All businesses require funding. This is as true for small businesses as it is for major enterprises. Thus, one of the most important steps you can take when pursuing your own entrepreneurial goals is to research your options and determine which best suits your needs.
At first, this can seem overwhelming. There are many different types of funding available to small business owners, each with its own pros, cons, and degree of risk. Some of the most popular options among new companies involve small business loans, term loans, lines of credit, and more.
This guide will simplify the issue. If you’re not sure where to start, keep the points below in mind.
The Basics of Small Business Funding
The old adage that “you need to spend money to make money” persists because it’s true. Regardless of what type of business you’re starting, you may need to pay for supplies, employees, marketing, office space, and much more. Odds are good you don’t have enough capital to cover all those expenses on your own.
That’s why small business owners typically secure funding from outside sources. This usually involves taking out a loan. Yes, that means you’ll be in debt, but without enough capital, you can’t generate enough revenue to sustain your business.
Again, you have numerous options when considering how to acquire startup capital. The following are some of the more common:
A term loan is simply a loan (typically provided by a bank or similar traditional lending entity) in which you are required to pay back in installments over a specified period of time. The lender profits by charging interest, the rate of which may be fixed or flexible.
The length of a term caries on a case-by-case basis. Generally, though, it will last between one and five years.
It’s worth noting that new small business owners may struggle to qualify for term loans. Lenders must be certain they aren’t taking major risks. Thus, it helps if your business has been around for long enough that you can prove you are financially responsible. Luckily, there are now online lenders which, by leveraging data available via the Internet, may be more likely to approve loans than a bank would.
That said, new entrepreneurs who can’t qualify for term loans may still qualify for short-term loans. As the name implies, you’re required to pay them back in a shorter amount of time than a regular term loan; usually between three and 18 months. The sum you’ll receive is smaller, but these are easier to qualify for, making them a convenient option for some small business owners. You can even receive a short-term loan with bad credit, although this will usually be costly.
The government has an interest in the success of small businesses, as they can stimulate the economy if they grow large enough. Thus, the Small Business Administration is often willing to help business owners secure the necessary loans to start or grow their businesses.
The SBA helps by agreeing to cover a large part of the loan (if the recipient defaults) when lenders work with small business owners. This reduces the degree of risk a lender is taking. While this is an option worth considering, qualifying for an SBA loan also requires substantial documentation.
Credit Cards & Lines of Credit
Business credit cards work essentially the same way as traditional credit cards. The only difference is that, as the name implies, you would only use this card on business expenses. This helps you separate your personal finances from your business finances. As with any credit card, though, you should be confident you can pay what you owe each month.
A business line of credit is slightly different. It gives you potential access to a certain amount of money (from $10,000 to greater than $1 million). However, you only pay interest on the funds you actually use. That makes a business line of credit useful if you ever need to make larger purchases. Like loans, there are also short term lines of credit, which are easier to qualify for than most others.
This is a unique option that may nevertheless be worth pursuing depending on the nature of your business.
In many industries, business owners need to purchase expensive pieces of equipment. When they can’t afford to pay for them, but are certain the revenue that equipment will yield is greater than the cost, they may acquire equipment financing from lenders.
With most business loans, lenders assess such factors as your credit score and general financial history when determining whether to approve a loan. This typically isn’t the case with equipment financing. Instead, lenders focus more on the equipment’s value. In many instances, they require small business owners to put up collateral in order to qualify. Over the course of several months, you’ll pay for the equipment in installments, with interest.
Merchant Cash Advances
Merchant cash advances are very easy to access. Even if you have bad credit, you can typically find a way to qualify for one.
This doesn’t mean they are always a perfect solution when you need cash soon. A merchant cash advance is a lump sum that you pay off by giving a lender a portion of your daily credit card sales. The problem is, with APRs typically ranging from 15% to as much as 80%, they can be very expensive. It’s best to only consider this option if your credit prevents you from securing any other type of funding.
All of the examples covered thus far fall under the category of debt financing. Equity financing represents a different approach.
It involves securing funding (and, in some instances, advice) from investors in exchange for a portion of your business. Angel investors, venture capitalists (which are essentially teams of angel investors), and even friends and family may be willing to provide you with capital if they believe that investing in your business will provide them with a substantial return-on-investment.
Be aware of the fact that relationships with friends or family can be strained if they invest in your business and it doesn’t succeed. While some people believe that going this route is ideal, it’s not always the case with everyone. You don’t want to ruin a close friendship or relationship with a loved one because you weren’t able to deliver on your promises.
The digital age has made it possible to fund a small business via crowdsourcing. With a strong Kickstarter campaign, you may be able to find people willing to support your business in exchange for some form of reward in the future.
If you have a 401(k), and are confident in your ability to succeed, you could also use it to help fund your business. In some cases, you might even qualify for a small business grant, although their requirements and criteria tend to be very specific.
Regardless of which option you choose, these are all points you need to remember when starting a small business. Don’t make the mistake of assuming you don’t need outside funding simply because you have enough cash now to start working towards your goals. Remember that expenses you didn’t plan for may very well arise in the future. By taking the time to research your options, you’ll be more likely to safely and successfully cover them when they do.