Debt Financing

Debt financing involves borrowing money that is repayable over a specific period of time at a predetermined interest rate. Debt financing also involves the pledging of various forms of collateral as security for the loan. Types of collateral include the land and building where the day spa or medical spa project is to be located, the equipment that will be used in the day-to-day operations of the project, leasehold improvements and unrelated commercial or residential real estate such as the owner's primary residence.

The most common sources of debt financing are local banks, savings and loans, commercial finance companies, and the U.S. Small Business Administration (SBA). State and local governments have developed many programs in recent years to encourage the growth of small businesses in recognition of their positive effects on the economy. Some loans may also come from family and friends.

In the past, the major source of small business funding has been local banks who make both long and short term loans, provide seasonal lines of credit, and extend single-purpose loans for machinery and equipment. Whether or not such a loan is approved often depends on the relationship between the owner and the bank.

Without such a relationship, banks generally have become reluctant to offer long-term loans to the owners of new, start-up day spas. The SBA guaranteed lending program encourages banks and non-bank lenders to make long-term loans to small firms by reducing their risk and leveraging the funds they have available. The SBA's programs have been an integral part of the success stories of thousands of firms nationally.

In addition to equity considerations, lenders commonly require the borrower's personal guarantees in case of default. This ensures that the borrower has a sufficient personal interest at stake to give paramount attention to the business. For most borrowers this is a burden, but also a necessity.

For additional information see: Small Business Administration

(Bridge Building)

In the case of day spa and medical spa financing, "equity" is generally defined as that amount of total project start-up costs that cannot be funded with either a bank or other loan or an equipment lease. Equity usually equals from ten percent (10%) to twenty percent (20%) of total cost.

As with loans or debt financing, equity for small day spa and medical spa businesses usually comes from non-professional investors such as the owner's friends, relatives or day spa industry colleagues. For larger projects, a common source of professional equity funding comes from venture capitalists. These are institutional risk takers and may be groups of wealthy individuals, government-assisted sources, or major financial institutions. Most specialize in one or a few closely related industries.

According to the Small Business Administration, "different venture capitalists have different approaches to management of the business in which they invest. They generally prefer to influence a business passively, but will react when a business does not perform as expected and may insist on changes in management or strategy. Relinquishing some of the decision-making and some of the potential for profits are the main disadvantages of equity financing."

You may contact these investors directly, although they typically make their investments through referrals. The SBA also licenses Small Business Investment Companies (SBIC's) and Minority Enterprise Small Business Investment companies (MSBI's), which offer equity financing. Apple Computer, Federal Express and Nike Shoes received financing from SBIC's at critical stages of their growth.

There are three basic sources of funding for the owners of small to medium sized day and medical spas:

• Debt financing usually in the form of a bank loan;
• Equipment leasing with an option to purchase at the termination of the lease; and
• Equity financing involving capital contributions of the owner or other investors.

The type of financing that is used will depend on the financial needs of the spa project, the financial statement and creditworthiness of the owner and the assets that the owner has available and is willing to pledge as collateral.

Equipment Leasing

Equipment leasing is an excellent method of funding the spa and salon equipment that is required for the new business. The lease term is usually from five to seven years which is the useful life of the equipment being leased. The lease rate varies depending on the financial condition of the owner and may range from a low which is commensurate to bank loans to a high that is commensurate with credit card rates.

The benefits of equipment leasing include little or no down payment with up to 100% of the purchase price being funded, immediate access to required equipment without having to wait for a loan closing, tax advantages such as the possible deductibility of lease payments, the freeing up the owner's funds or working capital for other purposes and the ability of purchasing the equipment at the termination or the lease at its then fair market value.

Equipment suppliers can make recommendations on the equipment leasing companies with whom they have good relationships.

A Tip from the Small Business Administration:

While poor management is cited most frequently as the reason businesses fail, inadequate or ill-timed financing is a close second. Whether you're starting a business or expanding one, sufficient ready capital is essential. But it is not enough to simply have sufficient financing; knowledge and planning are required to manage it well. These qualities ensure that entrepreneurs avoid common mistakes like securing the wrong type of financing, miscalculating the amount required, or underestimating the cost of borrowing money.

 Sidebar:

"Mr. Smith, you need to go to the bank early to determine whether or not you will be able to get a loan and, if so, its terms and conditions."