There a many different ways to finance a business. You could take out a loan, partner with an angel investor, or even apply for small business grants. We’re breaking down the most common forms of small business financing so that you have a better idea of what option is best for your business.
What is Small Business Financing?
Financing options give small businesses the funds they need to start, operate, and expand their business. Financing can be done through debt or equity and is offered by financial institutions, alternative lenders, and private parties.
You may need financing because –
1) You want to start a business and need to cover startup fees and costs.
2) You have a gap in cash flow due to delayed customer payments or because it’s off-season and you’re a seasonal business.
3) You encountered an unexpected expense, like office repairs or theft.
4) You have identified a business opportunity you can’t pass up, but you need more capital to take advantage of that opportunity.
5) You want to scale up your operations for long-term growth but need the capital to do so.
Answer These Questions About Your Business:
The answers to these questions can help you narrow down which loan or financing option will be best for your situation.
- What amount of financing do you need?
- What do you plan to spend the money on?
- How fast do you need access to the funds?
- What repayment term length will you need?
- How many years have you been in business?
- What is the present financial status of your business?
- How much collateral, if any, can you offer a lender?
- Would you be okay with sharing equity with investors?
Different Ways to Finance a Small Business
1. Term loans
These are traditional loans. You borrow a set amount and pay it back to the lender over a set period of time with a fixed interest rate. You could go for shorter-term loans (3-18 months), which may be easy to qualify for and give fast access to funds – but they also have higher interest rates and lower loan amounts. Longer-term loans (1-5 years) can have lower interest rates and higher fund amounts – but they are harder to qualify for and can take longer to process. In fact, some estimates say only 20% of applicants get approved for bank small business loans.
Popular lenders in this category include banks, credit unions, and an increasing number of online lenders.
Yet another option in the term loan category are Small Business Administration (SBA) loans. These business loans are found at normal lenders but are backed and insured by the government. This makes it easier to qualify for the loans since the lenders are taking less of a risk. These loans take the longest to get approved and receive financing.
SBA loans come in multiple forms, including 7(a) loans, microloans, and CDC/504 loans.
Used for: Most flexible usage, including working capital, purchase of equipment, land, or buildings, construction, renovation, new business capital, acquisition, operations, expansion, and debt refinancing
Loan amount: Up to $5 million
Term length: Up to 10 years for working capital and 25 years for fixed assets
Used for: New or growing small businesses for working capital, purchase of inventory and/or supplies
Loan amount: Up to $50,000
Term length: Up to 6 years
Used for: Major assets like equipment and/or real estate – SBA provides 40%, participating lender covers up to 50% and the borrower puts up the remaining 10%
Loan amount: Up to $5.5 million
Term length: 10 or 20-year terms
Tips to help get approved for a term loan:
- Improve your personal and business credit scores
- Only apply to lenders that you know you meet their minimum qualifications and/or requirements
- Gather all necessary financial and legal documents in advance, like tax returns, income statements, business licenses, etc
- Provide a solid business plan that shows your business projections
- Put up collateral, like inventory or a personal financial guarantee
2. Lines of credit
Business lines of credit provide access to a set amount of funds for a business to use when they need them. You only pay back interest on what you’ve used. Lines of credit are revolving debt, rather than fixed debt like a term loan. This is because what you owe changes based on what you decide to use. Your credit line could be anywhere from $10,000 to $1 million and interest rates generally range from 7%-25% APR.
Lines of credit can provide low rates and easy access to a large amount of capital, but they can also have harsher late repayment fees. Also, if you use the line of credit for multiple small purchases, you may not have access to the large capital amount you may need for a business opportunity.
3. Asset-based loans
While a traditional loan bases your qualification on credit history, these loans base your qualification by the assets you list as collateral. If you fail to repay that loan, the lender can seize the listed collateral. Two common types of asset-based loans are equipment financing and invoice financing.
Used for: Financing up to 100% of the cost of equipment
Interest rates: 8-30% APR
Invoice financing (a.k.a. accounts receivable financing)
Used for: Removing cash flow gaps by getting paid for invoices upfront by your lender while waiting on the client to pay the invoice
Fees: Dependent on lender
4. Credit cards
Business credit cards are easy to qualify for, often have high spending limits, and help you separate your personal and business expenses. They also come with rewards programs and cash back options. Look for credit cards that offer 0% introductory rates.
Keep in mind that credit cards can incur late payments or overdraft penalties if you use them incorrectly. Plus, if you have the ability to qualify for a bank loan, you will often get a better interest rate on that loan than a credit card.
5. Merchant Cash Advances
This financing option lends you a lump sum like a normal loan, but the repayment functions quite differently. Instead of fixed monthly payments, you agree to pay back the lender a portion of your daily credit card sales until the cash advance is repaid. These cash advances may seem ideal, but their rates are exponentially higher – up to 30% APR! This type of financing may be a good short-term fix, but if used incorrectly can hurt your bottom line.
6. Equity financing
Rather than borrow money in the form of debt, equity financing allows you to trade a portion of your business ownership in exchange for cash and possible mentorship. Equity financing can be more difficult to get and you have to be comfortable with other decision-makers in the room. But if you need mentorship and larger capital amounts – it could be a good option. Two popular types of equity financing include angel investors and venture capital firms.
These are individual investors who offer to invest in small businesses in exchange for monetary returns and possible decision-making power.
Venture capital firms
Instead of individuals, these are companies that invest in small businesses in exchange for monetary returns and possible decision-making power.
7. Miscellaneous Financing
There are many more ways you might seek financing. These include dipping into 401(k) savings, applying for small business grants, and even applying for competitions like Shark Tank. Make sure you talk to a financial professional to find out which options work best for your situation.
Need Help Deciding Which Option to Pursue?
Schedule an appointment with a small business advisor today! We can help you decide what financing is best for your needs and assist throughout the application process.