Equity Financing. Understanding the Basics of Financing Your Business. Borrowing Money. Types of Financing

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1 Understanding the Basics of Financing Your Business Have you thought about how you are going to fund your business? When considering financing options, it s a good idea to have an understanding of your financing needs as well as the types of options that available to help you start and sustain your business. In this section, SBA will help you assess the costs associated with startup and growth, the pros and cons of using your business versus your personal finances, the types of financing that exist, and the factors that banks evaluate when reviewing loan applications. We ll even help you to determine if your business may be eligible for SBA assistance programs. Borrowing Money Borrowing money is one of the most common sources of funding for a small business, but obtaining a loan isn't always easy. Before you approach a lender for a loan, it is a good idea to understand as much as you can about the factors the bank will evaluate when they consider your application. This page outlines some of the key factors a lender uses to analyze a potential borrower. Types of Financing There are two types of financing: equity financing and debt financing. When looking for money, you must consider your company's debt-to-equity ratio. This ratio is the relation between dollars you've borrowed and dollars you've invested in your business. The more money owners have invested in their business, the easier it is to attract financing. If your firm has a high ratio of equity to debt, you should probably seek debt financing. However, if your company has a high proportion of debt to equity, experts advise that you should increase your ownership capital (equity investment) for additional funds. That way you won't be over-leveraged to the point of jeopardizing your company's survival. Equity Financing Equity financing (or equity capital) is money raised by a company in exchange for a share of ownership in the business. Ownership is represented by owning shares of stock outright or having the right to convert other financial instruments into stock. Equity financing allows a business to obtain funds without incurring debt, or without having to repay a specific amount of money at a particular time. Most small or growth-stage businesses use limited equity financing. Equity often comes from non-professional investors such as friends, relatives, employees, customers, or industry colleagues. The most common source of professional equity funding is 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. The high-tech industry of California's Silicon Valley is a well-known example of venture capital investing. Venture capitalists are often seen as deep-pocketed financial gurus looking for start-ups in which to invest their money. But they most often prefer three- to five-year-old companies with the potential to become major regional or national concerns and to return higher-than-average profits to their shareholders. Venture capitalists may scrutinize thousands of potential investments annually, but only invest in a handful. The possibility of a public stock offering is critical to venture capitalists. Quality management, a competitive or innovative advantage, and industry growth are also major concerns.

2 Debt Financing Debt financing means borrowing money that must be repaid over a period of time, usually with interest. Debt financing can be either short-term, with full repayment due in less than one year, or long-term, with repayment due over a period greater than one year. The lender does not gain an ownership interest in the business, and debt obligations are typically limited to repaying the loan with interest. Loans are often secured by some or all of the assets of the company. In addition, lenders commonly require the borrower's personal guarantee in case of default. This ensures that the borrower has a sufficient personal interest at stake to give paramount attention to the business. Loans can be obtained from many different sources, including banks, savings and loans, credit unions, commercial finance companies, and SBA-guaranteed loans. 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. Family members, friends, and former associates are all potential sources, especially when capital requirements are smaller. Traditionally, banks have been the major source of small business funding. The principal role of banks has been as a short-term lender offering demand loans, seasonal lines of credit, and single-purpose loans for machinery and equipment. Banks generally have been reluctant to offer long-term loans to small firms. The SBA s guaranteed lending programs encourage 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. Ability to Repay The ability (or capacity) to repay the funds you receive from a lender must be justified in your loan package. Banks want to see two sources of repayment cash flow from the business as well as a secondary source such as collateral. The lender reviews the past financial statements of a business to analyze its cash flow. Generally, banks feel most comfortable dealing with a business that has been in existence for a number of years because it has a financial track record. If the business has consistently made a profit and that profit can cover the payment of additional debt, it is likely that the loan will be approved. If however, the business is a start-up or has been operating marginally and now has a new opportunity to grow, it is necessary to prepare a thorough loan package with a detailed explanation addressing how the business will be able to repay the loan. Credit History When a small business requests a loan, one of the first things a lender looks at is personal and business credit history. So before you even start the process of preparing a loan request, you want to make sure your credit is good. Get your personal credit report from one of the credit bureaus, such as TransUnion, Equifax or Experian. You should initiate this step well in advance of seeking a loan. Personal credit reports may contain errors or be out of date, and it can take three to four weeks for errors to be corrected. It's up to you to see that corrections are made, so make sure you check regularly on progress. You want to make sure that when the lender pulls your credit report, all the errors have been corrected and your history is up to date. Once you obtain your credit report, check to make sure that all personal information (your name, Social Security number and address) is correct. Then examine the rest of the report carefully. It contains a list of all the credit you obtained in the past (for example, for credit cards, mortgages, student loans), with information on how you paid that credit. Any item indicating that you have had a problem in paying will be toward the top of the list. These are the credits that may affect your ability to obtain a loan.

3 If you have been late by a month on an occasional payment, this probably will not adversely affect your credit. But it is likely that you will have difficulty in obtaining a loan if you are continuously late in paying your credit, have a credit that was never paid, have a judgment against you, or have declared bankruptcy in the last seven years. A person may have a period of bad credit as a result of divorce, medical crisis, or some other significant event. If you can show that your credit was good before and after this event and that you have tried to pay back those debts incurred in the period of bad credit, you should be able to obtain a loan. It is best if you write an explanation of your credit problems and how you have rectified them, and attach this to your credit report in your loan package. Each credit bureau has a slightly different way of presenting your credit information. For example, some use words rather than numbers. Good credits read "Never Late" or "Paid as Agreed." TransUnion uses number and letter combinations. "I" means installment credit, "R" means revolving credit. The key information is in the numbers. A "1" means perfect credit you ve always paid your bills on time. A "2" or "3" means you have been two- to threemonths late in paying your bills. Too many of these will hurt your chances in obtaining credit. A "9" means delinquency in paying your bills and a charge off. This could make it difficult to obtain a loan. You can get specific information on how to read the report from each credit bureau. If you need help in interpreting or evaluating your credit report, ask your accountant or a friendly banker. Equity Investment Don't be misled into thinking that a start-up business can obtain 100 percent financing through conventional or special loan programs. Financial institutions want to see a certain amount of equity in a business. Equity can be built up through retained earnings or by the injection of cash from either the owner or investors. Most banks want to see that the total liabilities or debt of a business is not more than four times the amount of equity (in other words, when you divide total liabilities by equity, your answer should not be more than four). So if you want a loan, you must make sure that there is enough equity in the company to leverage that loan. An owner usually must put some of her/his own money into the business to get a loan; the amount depends on the type of loan, purpose and terms. Most banks want the owner to put in at least 20 to 40 percent of the total request. For example, if a new business needs $100,000, the business owner must put $20,000 of his/her own money into the business as equity. The loan amount would be $80,000. The debt to equity ratio here is 4:1. Having the right debt to equity ratio does not guarantee you'll get a loan. There are a number of other factors used to evaluate a business, such as net worth, which is the amount of equity in a business (often a combination of retained earnings and owner's equity). Top of Page Collateral When a financial institution gives a loan, it wants to make sure it will get its money back. That s why a lender usually requires a second source of repayment, called collateral. Collateral is personal and business assets that can be sold in case the cash generated by the small business isn t sufficient to repay the loan. Every loan program requires at least some collateral. If a potential borrower has no collateral, he/she will need a co-signer who has collateral to pledge. Otherwise it may be difficult to obtain a loan. The value of collateral is not based on market value; rather, it is discounted to take into account the value that would be lost if the assets had to be liquidated. This table gives a general approximation of how different forms of collateral are valued by a typical lender and the SBA:

4 COLLATERAL TYPE LENDER SBA House Market Value x Mortgage balance Market Value x Mortgage balance Car Not applicable Not applicable Truck & Heavy Equipment Depreciated Value x 0.50 Same Office Equipment Not applicable Not applicable Furniture & Fixtures Depreciated Value x 0.50 Same Inventory: Perishables Not applicable Not applicable Jewelry Not applicable Not applicable Other 10%-50% 10%-50% Receivables Under 90 days x 0.75 Under 90 days x 0.50 Stocks & Bonds 50%-90% 50%-90% Mutual Funds Not applicable Not applicable Individual Retirement Account (IRA) Not applicable Not applicable Certificate of Deposit (CD) 100% 100% Collateral Coverage Ratio The bank will calculate your collateral coverage ratio as part of the loan evaluation process. This ratio is calculated by dividing the total discounted collateral value by the total loan request. Management Experience Managerial expertise is a critical element in the success of any business. In fact, poor management is most frequently cited as the reason businesses fail. So lenders will be looking closely at your education and experience as well as that of your key managers. If you d like to strengthen your management skills, the SBA s Online Training offers a variety of free online courses that you can take on your own time and at your own pace.

5 Questions Your Lender Will Ask Before you apply for a loan, you need to think about a variety of questions: Can the business repay the loan? (Is cash flow greater than debt service?) Can you repay the loan if the business fails? (Is collateral sufficient to repay the loan?) Does the business collect its bills? Does the business pay its bills? Does the business control its inventory? Does the business control expenses? Are the officers committed to the business? Does the business have a profitable operating history? Does the business match its sources and uses of funds? Are sales growing? Are profits increasing as a percentage of sales? Is there any discretionary cash flow? What is the future of the industry? Who is your competition and what are their strengths and weaknesses? Using Business vs. Personal Finances Starting up a business can be a tremendous strain on your personal finances. It can take six months or more before your new venture is profitable and can provide financial support for you and your family. Before going into a business, it's always wise to get your finances in order. To get started, write a monthly household budget that accounts for your income and your household expenses. Be as conservative as possible, because it is vital to your success that you have the resources to maintain your household expenses while your business is growing. Any strain on your personal budget can also put the financial success of your business at risk. It is also a good idea to check your personal credit situation. Too often, entrepreneurs think that their business credit and personal credit are separate, but business credit is built upon the owner's personal credit. Because you have not established a business credit history, lenders and suppliers will use your personal credit history to determine your terms of credit. Your credit report, which is issued by a credit bureau, determines how you will be perceived by potential lenders and suppliers. You should know what appears on your credit report because you may find errors that you will want to have corrected. You can get a copy of your personal credit report from one of the three major credit bureaus: Equifax, Experian, or TransUnion.

6 Estimating Startup Costs If you are planning to launch a business venture, it is vitally important to know that you will have enough money to keep it afloat. Every business is different, and has its own specific cash needs at different stages of development, so there is no universal method for estimating your startup costs. Some businesses can be started on a shoestring budget, while others may require considerable investment in inventory or equipment. Additional considerations may include the cost to acquire or renovate a building or the acquisition of long-term equipment. To determine how much seed money you need to start, you must estimate the costs of doing business for at least the first several months. Some of these expenses will be one-time costs such as the fee for incorporating your business or the price of a sign for your building. Some will be ongoing costs, such as the cost of utilities, inventory, insurance, etc. While identifying these costs, decide whether they are essential or optional. A realistic startup budget should only include those things that are necessary to start the business. These essential expenses can then be divided into two separate categories: fixed and variable. Fixed expenses include rent, utilities, administrative costs and insurance costs. Variable expenses include inventory, shipping and packaging costs, sales commissions, and other costs associated with the direct sale of a product or service. The most effective way to calculate your startup costs is to use a worksheet that lists the various categories of costs (both one-time and ongoing). Financial Statements Understanding financial statements is essential to the success of a small business. Financial statements can be used as a roadmap on your business journey to economic success. Using numbers as navigation aids can steer you in the right direction and help you avoid costly "breakdowns." Most business owners don't realize that financial statements have a value that goes far beyond their use to prepare tax returns or loan applications. Below you will find information on the primary financial statements: the balance sheet and the income statement. Balance Sheet The balance sheet is a snapshot of the company's financial position at an instant in time. It shows what the company owns (assets) and what it owes (liabilities and net worth). The "bottom line" of a balance sheet must always balance (assets = liabilities + net worth) The individual elements of a balance sheet change from day to day and reflect the activities of the company. Analyzing how the balance sheet changes over time will reveal important information about the company's business trends. You can monitor your ability to collect revenues, how well you manage your inventory, and even assess your ability to satisfy creditors and stockholders. Liabilities and net worth on the balance sheet represent the company's sources of funds. Liabilities and net worth are composed of creditors and investors who have provided cash or its equivalent to the company. As a source of funds, they enable the company to continue in business or expand operations. If creditors and investors are unhappy and distrustful, the company's chances of survival are limited. Assets, on the other hand, represent the company's use of funds. The company uses cash or other funds provided by the creditor/investor to acquire assets. Assets include all the things of value that are owned or due to the business.

7 Liabilities represent a company's obligations to creditors while net worth represents the owner's investment in the company. In reality, both creditors and owners are "investors" in the company with the only difference being the degree of nervousness and the timeframe in which they expect repayment. Assets Anything of value that is owned or due to the business is included under the Asset section of the Balance Sheet. Assets are shown at net book or net realizable value (more on this later), but appreciated values are not generally considered. Current Assets Current assets mature in less than one year. They are the sum of: Cash Cash Accounts Receivable (A/R) Inventory Notes Receivable (N/R) Other current assets Cash pays bills and obligations. Inventory, receivables, land, building, machinery and equipment do not pay obligations even though they can be sold for cash and then used to pay bills. If cash is inadequate or improperly managed, the company may become insolvent and be forced into bankruptcy. Cash includes all checking, money market and short-term savings accounts. Accounts Receivable (A/R) Accounts receivable are dollars due from customers. They arise as a result of the process of selling inventory or services on terms that allow delivery prior to the collection of cash. Inventory is sold and shipped, an invoice is sent to the customer, and later cash is collected. The receivable exists for the time period between the selling of the inventory and the receipt of cash. Receivables are proportional to sales. As sales rise, the investment you must make in receivables also rises. Inventory Inventory consists of the goods and materials a company purchases to resell at a profit. In the process, sales and receivables are generated. The company purchases raw material inventory that is processed (called work-in-process inventory) to be sold as finished goods inventory. For a company that sells a product, inventory is often the first use of cash. Purchasing inventory to be sold at a profit is the first step in the profit-making cycle (operating cycle). Selling inventory does not bring cash back into the company it creates a receivable. Only after a time lag equal to the receivable's collection period will cash return to the company. Thus, it is very important that the level of inventory be well managed so that the business does not keep too much cash tied up in inventory, as this will reduce profits. At the same time, a company must keep sufficient inventory on hand to prevent stockouts (having nothing to sell) because this, too, will erode profits and may result in the loss of customers. Notes Receivable (N/R) N/R is a receivable due the company, in the form of a promissory note, arising because the company made a loan. Making loans is the business of banks, not of operating business, and particularly not the business of a small company with limited financial resources. Notes receivable is probably a note due from one of three sources: customers, employees or officers of the company.

8 Customer notes receivable is when the customer who borrowed from the company probably borrowed because he could not meet the accounts receivable terms (when the customer failed to pay the invoice according to the agreedupon payment terms). The customer's obligation may have been converted to a promissory note. Employee notes receivable may be for legitimate reasons, such as a down payment on a home, but the company is neither a charity nor a bank. If the company wants to help an employee, it can co-sign on a loan advanced by a bank. An officer or owner borrowing from the company is the worst form of note receivable. If an officer takes money from the company, it should be declared as a dividend or withdrawal and reflected as a reduction in net worth. Treating it in any other way leads to possible manipulation of the company's stated net worth, and banks and other lending institutions frown greatly upon this practice. Other Current Assets Other current assets consist of prepaid expenses, and other miscellaneous and current assets. Fixed Assets Fixed assets represent the use of cash to purchase physical assets whose life exceeds one year, such as: Land Building Machinery and equipment Furniture and fixtures Leasehold improvements Intangibles Intangibles represent the use of cash to purchase assets with an undetermined life and they may never mature into cash. For most analysis purposes, intangibles are ignored as assets and are deducted from net worth because their value is difficult to determine. Intangibles consist of assets such as: Research and development Patents Market research Goodwill Organizational expense In several respects, intangibles are similar to prepaid expenses the use of cash to purchase a benefit which will be expensed at a future date. Intangibles are recouped, like fixed assets, through incremental annual charges (amortization) against income. Standard accounting procedures require most intangibles to be expensed as purchased and never capitalized (put on the balance sheet). An exception to this is purchased patents that may be amortized over the life of the patent. Other Assets Other assets consist of miscellaneous accounts, such as deposits and long-term notes receivable from third parties. They are turned into cash when the asset is sold or when the note is repaid. Total Assets Total Assets represent the sum of all the assets owned by or due to the business. Liabilities and Net Worth

9 Liabilities and Net Worth are sources of cash listed in descending order from the most nervous creditors and soonest to mature obligations (current liabilities), to the least nervous and never due obligations (net worth). There are two sources of funds: lender-investor and owner-investor. Lender-investor funds consist of trade suppliers, employees, tax authorities and financial institutions. Owner-investor funds consist of stockholders and principals who loan cash to the business. Both lender-investor and owner-investors have invested cash or its equivalent into the company. The only difference between the investors is the maturity date of their obligations and the degree of their nervousness. Current Liabilities Current liabilities are those obligations that will mature and must be paid within 12 months. These are liabilities that can create a company's insolvency if cash is inadequate. A happy and satisfied set of current creditors is a healthy and important source of credit for short-term uses of cash (inventory and receivables). An unhappy and dissatisfied set of current creditors can threaten the survival of the company. The best way to keep these creditors happy is to keep their obligations current. Current liabilities consist of the following obligation accounts: Accounts Payable (A/P) Accrued expenses Notes Payable (N/P) Current portion of Long-Term Debt (LTD) Proper matching of sources and uses of funds requires that short-term (current) liabilities must be used only to purchase short-term assets (inventory and receivables). Accounts Payable (A/P) Accounts Payable are obligations due to trade suppliers who have provided inventory or goods and services used in operating the business. Suppliers generally offer terms (just like you do for your customers), since the suppliers' competition offers payment terms. Whenever possible you should take advantage of payment terms, as this will help keep your costs down. If the company is paying its suppliers in a timely fashion, days payable will not exceed the terms of payment. Accrued Expenses Accrued Expenses are obligations owed but not billed such as wages and payroll taxes, or obligations accruing, but not yet due, such as interest on a loan. Accruals consist primarily of wages, payroll taxes, interest payable and employee benefits accruals such as pension funds. As a labor-related category, it should vary in accordance with payroll policy (for example, if wages are paid weekly, the accrual category should seldom exceed one week's payroll and payroll taxes). Notes Payable (N/P) Notes payable are obligations in the form of promissory notes with short-term maturity dates of less than 12 months. Often, they are demand notes (payable upon demand). Other times they have specific maturity dates (30, 60, 90, 180, 270, 360 days maturities are typical). The notes payable always include only the principal amount of the debt. Any interest owed is listed under accruals. The proceeds of notes payable should be used to finance current assets (inventory and receivables). The use of funds must be short-term so that the asset matures into cash prior to the obligation's maturation. Proper matching

10 would indicate borrowing for seasonal swings in sales, which cause swings in inventory and receivables, or to repay accounts payable when attractive discount terms are offered for early payment. Non-current Liabilities Non-current liabilities are those obligations that will not become due and payable in the coming year. There are three types of non-current liabilities, only two of which are listed on the balance sheet: Non-current portion of Long-Term Debt (LTD) Notes Payable to Officers, Shareholders, or Owners Contingent Liabilities Non-current portion of long-term debt is the principal portion of a term loan not payable in the coming year. Subordinated officer loans are treated as an item that lies between debt and equity. Contingent liabilities listed in the footnotes are potential liabilities, which hopefully never become due. Non-current Portion of Long-Term Debt (LTD) Non-Current portion of LTD is the portion of a term loan that is not due within the next 12 months. It is listed below the current liability section to demonstrate that the loan does not have to be fully liquidated in the coming year. LTD provides cash to be used for a long-term asset purchase, either permanent working capital or fixed assets. Notes Payable to Officers, Shareholder or Owners Notes payable to officers, shareholders or owners represent cash that the shareholders or owners have put into the business. For tax reasons, owners may increase their equity investment beyond the initial company capitalization by making loans to the business rather than purchasing additional stock. Any return on investment to the owners can therefore be paid as tax-deductible interest expense rather than as non-tax-deductible dividends. When a business borrows from a financial institution, it is common for the officer loans to be subordinated or put on standby. The subordination agreement prohibits the officer from collecting his or her loan prior to the repayment of the institution's loan. When on standby, the loan will be considered as equity by the financial institution. Notes receivable officer are considered a bad sign to lenders, while notes payable officer are considered to be reassuring. Contingent Liabilities Contingent Liabilities are potential liabilities that are not listed on the balance sheet. They are listed in the footnotes because they may never become due and payable. Contingent liabilities include lawsuits, warranties and cross Guarantees. If the company has been sued, but the litigation has not been initiated, there is no way of knowing whether or not the suit will result in a liability to the company. It will be listed in the footnotes because, while not a real liability, it does represent a potential liability which may impair the ability of the company to meet future obligations. Alternatively, if the company guarantees a loan made by a third party to an affiliate, the liability is contingent because it will never become due as long as the affiliate remains healthy and meets its obligations. Total Liabilities Total liabilities represent the sum of all monetary obligations of a business and all claims creditors have on its assets.

11 Equity Equity is represented by total assets minus total liabilities. Equity or Net Worth is the most patient and last to mature source of funds. It represents the owners' share in the financing of all the assets. Income Statement The income statement, also known as the profit and loss statement, shows all income and expense accounts over a period of time that is, it shows how profitable the business is. This financial statement shows how much money the company will make after all expenses are accounted for. An income statement does not reveal hidden problems, like insufficient cash flow. Income statements are read from top to bottom and represent earnings and expenses over a period of time. Businesses Eligible & Ineligible For SBA Assistance While the vast majority of businesses are eligible for financial assistance from the SBA, some are not. In general, applicant businesses must: Operate for profit Be engaged in, or propose to do business in, the United States or its possessions Have reasonable owner equity to invest Use alternative financial resources, including personal assets, before seeking financial assistance Special Considerations Special considerations apply to some types of businesses and individuals. Franchises are eligible, except in situations where a franchiser retains power to control operations to such an extent as to be tantamount to an employment contract. The franchisee must have the right to profit from efforts commensurate with ownership. Recreational facilities and clubs are eligible provided: (a) the facilities are open to the general public, or (b) in membership-only situations, membership is not selectively denied to any particular group of individuals, and the number of memberships is not restricted either as a whole or by establishing maximum limits for particular groups. Farms and agricultural businesses are eligible; however, these applicants should first explore the Farm Service Agency (FSA) programs, particularly if the applicant has a prior or existing relationship with FSA. Fishing vessels are eligible; however, those seeking funds for the construction or reconditioning of vessels with a cargo capacity of five tons or more must first request financing from the National Marine Fisheries Service (NMFS), a part of the Department of Commerce. Medical facilities (hospitals, clinics, emergency outpatient facilities, and medical and dental laboratories) are eligible. Convalescent and nursing homes are eligible, provided they are licensed by the appropriate government agency and services rendered go beyond those of room and board. An Eligible Passive Company (EPC) is a small entity that does not engage in regular and continuous business activity. An EPC must use loan proceeds to acquire or lease, and/or improve or renovate real or personal property

12 that it leases to one or more Operating Companies for conducting the Operating Company's business. The EPC must comply with the conditions set forth in 13 CFR Sec Change of ownership. Loans for this purpose are eligible provided the business benefits from the change. In most cases, this benefit should be seen in promoting the sound development of the business or, perhaps, in preserving its existence. Loans cannot be made when proceeds would enable a borrower to purchase: (a) part of a business in which it has no present interest; or (b) part of an interest of a present and continuing owner. Loans to affect a change of ownership among members of the same family are discouraged. Legal aliens are eligible; however, consideration is given to the type of status possessed (for example, resident, lawful temporary resident, etc.) in determining the degree of risk relating to the continuity of the applicant's business. Excessive risk may be offset by full collateralization. Use USCIS Form G-845 for verification of citizenship. Probation or parole. Applications will not be accepted from firms where a principal (any one of those required to submit a personal history statement, SBA Form 912) is currently incarcerated, on parole, on probation or is a defendant in a criminal proceeding. This restriction would not necessarily preclude a loan to a business where a principal had responded in the affirmative to any one of the questions on the Statement of Personal History. These judgments are made on a case-by-case evaluation of the nature, frequency, timing of the offenses, and disposition of the offenses. Fingerprint cards (available from the local SBA office) are required only when a felony offense is disclosed. Ineligible Businesses Ineligible businesses include those engaged in illegal activities, loan packaging, speculation, multi-sales distribution, gambling, investment or lending, or where the owner is on parole. Specific types of businesses not eligible include: Real estate investment firms, when the real property will be held for investment purposes as opposed to loans to otherwise eligible small business concerns for the purpose of occupying the real estate being acquired. Firms involved in speculative activities that develop profits from fluctuations in price rather than through the normal course of trade, such as wildcatting for oil and dealing in commodities futures, when not part of the regular activities of the business. Dealers of rare coins and stamps are not eligible. Firms involved in lending activities, such as banks, finance companies, factors, leasing companies, insurance companies (not agents), and any other firm whose stock in trade is money. Pyramid sales plans, where a participant's primary incentive is based on the sales made by an ever-increasing number of participants. Such products as cosmetics, household goods, and other soft goods lend themselves to this type of business. Firms involved in illegal activities that are against the law in the jurisdiction where the business is located. Included in these activities are the production, servicing, or distribution of otherwise legal products that are to be used in connection with an illegal activity, such as selling drug paraphernalia or operating a motel that permits illegal prostitution. Gambling activities, including any business whose principal activity is gambling. While this precludes loans to racetracks, casinos, and similar enterprises, the rule does not restrict loans to otherwise eligible businesses, which obtain less than one-third of their annual gross income from either the sale of official state lottery tickets under a state license, or legal gambling activities licensed and supervised by a state authority

13 Charitable, religious, or other nonprofit or eleemosynary institutions, government-owned corporations, consumer and marketing cooperatives, and churches and organizations promoting religious objectives are not eligible.