Guide: Small Business Financing (How to Finance a Business)
When you’ve got a great idea and the ambition to get started, the final hurdle is often answering the question of how to finance a business.
Even if you have a business that can generate income quickly, most companies will need funding initially. Consider the business financing options that are available.
There are so many key questions to consider when embarking on this process. Sources of finance for small businesses come in many guises, and it’s important to carefully consider your business financing options.
Things to consider before seeking financing
The first questions to determine are as follows:
- What are the various ways to finance a business?
- How much small business financing do you require?
- For how long?
- When do you need it?
- What security can you provide on financing your business?
- Are you prepared to sacrifice part of the control of the business in exchange for financing your business?
Why seek financing for your small business?
Financing a small business can be tricky, but is often sought out for the following reasons:
- To cover setup costs.
- To assist with initial investments required in capacity (i.e., fixed assets required to run the business – like renting out a property, buying machinery, etc.).
- Working capital to ensure you are able to operate the business.
- Financing your business for growth and development opportunities.
Of course, you can always ask friends and family for small business financing or draw from your own savings.
This is typically where small business financing comes from initially, as in if you are passionate about financing a business and the idea behind it, you should be willing to fund it to an extent.
Image Source: How to Finance a Business & Sources of Funding
This is one of the great ways to finance a business because it inspires other investors thinking of financing a small business as well: if you are invested, they know you will be working as hard as possible to see a return, as your own interests are tied to the business’s success.
Be balanced in your approach to this form of small business financing – don’t expect all funding to come from your nearest and dearest, as you don’t want to be the harbinger of doom if things don’t go as expected. You also don’t want to overinvest from your savings, particularly if you are not taking a wage at the initial stages of your business operation.
To keep relationships positive, approach family and friends in the same way you would any external investor or other sources of finance for small businesses. Have a business plan ready, and be able to communicate all the aspects of the business and its place in the wider market.
Show your loved ones your projections, and put them at ease that there will not be an unhappy surprises down the line.
Be clear about what you are offering and asking for with these business financing options– do you require a loan only, or will it be in exchange for equity? Think carefully and communicate openly to avoid any potential family or friend fallout as a result of your personal small business financing source.
Bank loans are just one of the alternative business financing options that come in a huge variety of sizes, with all sorts of rates and fees attached. These can be short-term, mid-term or long-term sources of financing your business. This means you can easily find an alternative business financing source that suits your specific needs.
Bank loans also come with more stable terms – they provide a safety net, being a secure form of small business financing with clear, pre-agreed terms. Some banks, like Bank of America, have specific sources of finance for small businesses, which means you are in good shape to pitch your business plan to them.
Do your research on how to finance a business before you commit, as there are certainly plenty of loans with very high rates attached.
Try to focus on fixed-rate or capped-rate loans. You will secure better terms for financing a business if you have a clear business plan prepared. Show your bank that you have prepared, that your business is ready to receive funding, and that you have a clear set of projections regarding the cashflow forecast. Don’t forget to factor in interest: you must be able to cover interest on repayments with your expected cash flow.
Credit card funding is one of the most popular sources of financing a small business with fewer than 5 employees. It makes sense, being a straightforward and common source of small business financing for many.
However, it should be noted that this could be easily confused with a personal line of credit. The bank will require a guarantor of all debts financing a business, which will mean you are responsible – unless your business is incorporated.
Sole proprietorships are very common among small businesses in the US; therefore, you should be careful if you fall behind on payments, as your personal credit rating will be at risk. Seek alternative business financing options if this sounds too risky. However, these can be a source of small business financing that is easier to obtain and manage.
Secure funding from a range of credit cards – generally an easy follow-on from any association you might have with a bank and one of the common sources of finance for small businesses.
If you don’t have existing credit (or bad personal credit) you may wish to investigate secured business credit cards for small business financing. However, there are always unsecured cards which will offer better rates. Be sure to examine the rates and risks associated with each card carefully, and seek out relevant and helpful rewards to boost your purchasing power for your business.
SBA 7(a) Loans
Unfortunately, the federal government does not currently provide grants for private small business financing – only to non-commercial organizations like charities. However, it does support SBA loans.
There is a wealth of opportunities for alternative business financing for startups and small businesses when you are looking at how to finance a business. However, they are also very popular and highly sought after.
Image Source: Small Business Financing
SBA loans came about in response to the credit crisis, with banks becoming far more risk-adverse as a result of the crisis. So these sources of finance for small businesses help to ease credit concerns by guaranteeing lenders a portion of the loan should a loss be incurred through nonpayment. This is, therefore, a very popular small business-financing program that is supported by the federal government.
Local and state economic development organizations will tend to offer really great options in this vein for financing a business. Furthermore, in order to compete with bigger banks and alternative business financing sources, they will charge much lower interest. They may also lend portions of loans without the need for personal equity shares or warrants. The entire point of these organizations is to encourage local investment, so if you are based somewhere where startups are really encouraged, you’re in particularly good luck!
Smaller amounts here will have worse interest rates, so it’s worth investigating how to finance a business across banks. Banks will also tend to take service fees and sometimes offload the guaranteed portion of the loan to an insurance company or pension scheme – in which case, an external or third-party lender may be able to offer better deals.
Be aware that there are a variety of factors for which your business must qualify. These include proving that financing a small business like yours would not be possible in another way, and that it couldn’t obtain the money on its own.
In other words, you need to first apply for a loan from your bank and be rejected. You also need to meet the government definition of a small business within your industry and research any other restrictions or qualifications depending on the nature of the loan you are seeking.
If you’re willing to sacrifice some equity, you can secure investment from distinguished experts to finance a small business. Angel investors tend to look for new business opportunities that fit with their knowledge and expertise, adding credibility to your business concept should they invest (as they tend to be well-established in the industry). This is one of the best ways to finance a business and combine networking opportunities.
It can be tricky when you pitch to an angel investor because of the personal experience attached – you will need to prove you have the right kind of vision to appeal to those investors financing a business who are likely much more experienced than you might be. Compared to other business financing options, this can be very subjective. So be certain you have a solid team including a good amount of experience among your management ranks.
Make sure that your pitch shows you are looking for long-term returns and growth from those considering financing a small business and that it’s not just a business built on a whim. Be knowledgeable about your industry, and show you’ve performed the requisite market analysis to set you in good standing for utilizing any small business financing you receive.
If you receive some interest though no commitment upfront, don’t be alarmed. Make sure to follow up on angel investors and come back to them in the future when you have a record of work behind you. Keep all parties up to date with developments, and earn the trust to secure future small business financing.
Utilize Your 401(k)
If you’ve worked for a while and you’re thinking about how to finance a business or starting your own business, your 401(k) will have some funds. However, you will likely need assistance to set up a method of using these, as it can be a little legally obscure compared to other business financing options.
You can hire someone to assist in setting this up on your behalf, securing your small business financing. It requires you to create a C corporation, ensure the 401(k) is tied to this corporation, roll retirement funds into the new plan, and then use the money in your 401(k) to buy shares in your business. This way you are financing a small business directly yourself.
Ensure that you still have a fallback option for the future and don’t find yourself without a retirement fund in place.
Factoring is one of the sources of finance for small businesses to secure funds fast. It involves financing a business by selling your invoices to a third party at a discount; invoices raise money quickly and can be for almost anything – manufacturing services, products sold, etc.
This is one of the ways to finance a business that can sound a little complicated. However, in essence, the factor who buys the receivable (i.e., invoice), provides payment for this, and the debtor (i.e., your business) will need to make a payment to the new owner of the invoice at a later time. Financing a small business becomes possible as the invoice becomes an asset, and the factor is allowed to collect money on this in due course.
This process may not apply to financing a business like yours as they require business or commercial clients. By using factoring, you can obtain cash quickly in order to meet your upfront needs for small business financing. Some banks will have factoring practices, and there are also independent factoring companies who can help with financing your business.
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Crowdfunding campaigns are becoming an increasingly popular alternative business financing option for those ideas looking to get off the ground or for those who are otherwise unsure about how to finance a business in a more traditional way.
These sites allow the average person to pool his or her resources alongside many others, meaning that individual can invest as little as $5 to a cause. It’s essentially raising capital from a crowd of people that are financing a small business. If you attract enough people interested in financing a business, however, this starts to add up!
The biggest US-based site for financing a business is undoubtedly Kickstarter, which allows you to upload rich media content to showcase your business pitch.
However, it’s important to note that these sites tend to offer an all-or-nothing deal: if you fail to reach your set target, you don’t receive a dime. These crowdfunding business financing options can be good for companies needing the money for product manufacture – it is a neat way to secure preorders of products.
Clever marketing is really essential here for financing a small business idea as your only measure for success is how well aware the public becomes of your idea and how passionately they agree with what you hope to achieve.
Putting yourself out there can be tough, but this is becoming one of the most popular ways to finance a business for unique projects and ideas, without the need for repayments with interest attached.
Don’t forget that these platforms will use PayPal or similar, so deduct a 2–3.5% charge from your total in fees. This also all comes at the cost of giving something away for each individual’s investment in financing a business, whether it’s product, an experience or equity for having seen the business’s potential and having invested upfront.
There are many options for financing a small business. They each come with their varied pros and cons which is why our initial key questions surrounding how to finance a business are vital for consideration before beginning the funding process. Find your business’s priority, and research the ways to finance a business accordingly. There are a lot of options; hopefully, one will be the right method for securing your small business financing!
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