Wednesday, November 25, 2015

The Definitive Guide to Small Business Funding

As an entrepreneur, you have plenty of experience in conquering unknowns. From your first day learning how to write a business plan to applying for your first business license, hiring your first employees, dealing with taxes and accounting and legal considerations… You’ve probably figured out by now that every step in the process of starting and growing your business is going to involve learning something new.

Now that you’re on the hunt for funding to help your business grow, we hope to make this particular learning curve a little easier by taking some guesswork out of the equation. From investors to business loans to friends and family and more, here’s the play-by-play on all the different small business funding options available—and how to choose the best one for you.

Know Your Small Business Funding Options

Most funding options you’ll consider will fall into one of two categories: equity financing, where you give up partial ownership of your business or future profits in return for funding, and debt financing, where you’ll borrow a set amount of cash and then pay it back over time with interest. There are also some other creative ways of small business funding that don’t involve specific debt or equity that we’ll outline later on.

Below, we’ll describe more than a dozen of the most popular opportunities that small business owners pursue when looking for funding.

Equity Financing

As mentioned earlier, equity financing is any form of financing in which shares of or a percentage stake in your business are exchanged for cash or capital. This can be through an individual investor or through a capital investment firm.

In some cases, business owners obtain equity financing through a personal contact, friend, or family member. We’ll talk about funding through friends and family members later on, but for now let’s take a look at the two most typical sources of equity financing—angel investors and venture capital firms.

Angel Investors

Angel investors are individuals of means—often successful entrepreneurs themselves—who choose to personally invest in a wide variety of startup ventures as a means of furthering their own incomes and giving back to other entrepreneurs with their resources and expertise.

As an entrepreneur in need, the name “angel” investor may feel like a fitting label for anyone willing to hand over time, money, and expertise to make your startup venture a success. Keep in mind, though, an angel investor relationship is only as successful as the rapport established between the two individuals. If you’re pursuing opportunities through angel investors for your business, take the time to find an individual with whom you mesh well, who shares a similar vision for your business, and who will help you make that vision a reality.

In exchange for their funds and expertise, these angel investors will not only be getting individual equity shares in your business, but in many cases they’ll also obtain a certain amount of decision-making power. So before you hand over the proverbial keys to your business to an angel investor, be sure you’ve agreed to drive in the same direction.

Venture Capital Firms

Similar to angel investors, venture capital firms are organized and established organizations that fund larger scale business ventures by purchasing a percentage of the business in a startup’s “round” of funding.

Typically, as a business owner, you would decide to pursue a funding round, determine a set amount of capital you want to raise in exchange for a certain percentage of equity, then pitch to a few different venture capital firms in the hopes of finding a match.

Funding your business through a venture capital firm can be highly competitive, and has a certain barrier to entry that not all small business owners are able to meet. Most venture capital firms make minimum investments in the million dollar range, so consider this option only if you’re on the hunt for large scale funding.

Debt Financing

In the most basic terms, debt financing is any form of funding that requires your business to repay principal plus interest to an individual, lender, or financial institution. This includes traditional business loans, as well as a wide variety of different loan products that businesses can choose from to access small business funding.

The common link between these products is that they all involve some sort of repayment terms—meaning your business, and in many cases you as the owner, are held liable for that repayment.

Let’s take a look at the various types of debt financing products you might consider to fund your business.

Term Loans

A traditional term loan is the easiest type of debt financing to understand: it’s probably what you think of when you think of a business loan. You borrow a fixed amount of money, usually for a specifically stated business purpose, and pay back the loan over a fixed term and at a fixed interest rate.

If you’re looking for a loan with a fixed interest rate and predictable monthly payments that can be used for a wide range of business purposes, a term loan would likely be your first and most obvious choice.

SBA Loans

Within the umbrella of traditional term loans are a variety of products offered through the U.S. Small Business Administration (SBA), a federal agency dedicated to helping entrepreneurs improve their businesses, take advantage of contracting opportunities, and gain access to small business funding.

Although the SBA doesn’t directly loan money to businesses, the agency incentivizes lenders to approve small businesses for borrowing by approving all or part of their loans. Lower risk, higher reward. 

There are three main SBA loan programs that help a wide variety of small businesses obtain debt financing:

7(a) Loan Program

The 7(a) loan program is the most common out of the SBA’s various programs because it offers the most open-ended terms and qualifications. Through this program, borrowers can access up to $5 million in funds for working capital, equipment purchases, real estate buys, basic startup costs, or even debt refinancing.

Qualification is left to the discretion of intermediary lenders, who also determine the interest rates and total cost of the loan. However, the backing of the SBA does often make lenders more likely to approve term loans through this program than they otherwise would.

Microloan Program

Many solopreneurs and micro-entrepreneurs struggle with access to debt financing because the loan sizes they typically need don’t meet most lenders’ lower limits. To address this challenge, the SBA created its microloan program, which provides lending opportunities for entrepreneurs in need of between $500 and $50,000 in funding. The average microloan amount is about $13,000.

These loans are designed for businesses who’ve never before received a bank loan and who have low or nonexistent business credit history. As with the 7(a) loans, exact rates and eligibility standards are guided by the SBA, but ultimately left to the discretion of the intermediary lender.

CDC/504 Loan Programs

The SBA’s CDC/504 loan programs are designed for businesses looking to make a major fixed asset purchase—like large equipment, land improvements, or the purchase or renovation of an existing building. Borrowers through this program can take out up to $5 million, with repayment terms of up to 20 years and interest rates based on current treasury rates.

Keep in mind, though, that these are the most highly regulated of all SBA loans, so typically only well-established small businesses with a long and strong credit history will be able to qualify.

Equipment Financing

Applying for an equipment loan can be a quick, streamlined way to access funds to purchase computers, machinery, vehicles, or virtually any other equipment for your business. Similar to with a car loan, the equipment itself acts as collateral, so you’re more likely to be approved without offering separate collateral than you would be with other types of loans.

Invoice Financing

If delayed payments from clients are seriously endangering your cash flow, invoice financing is a great option to get your receivables back on track.

Also known as accounts receivables financing, invoice financing is a system in which companies buy your accounts receivable through a quick cash advance of about 80% of the value of your invoices. Later on, you’ll receive most of the additional 20% you’re owed proportional to the amount of your invoices that were actually repaid.

Merchant Cash Advance

A merchant cash advance is a lump sum payment of liquid capital offered to a business in exchange for a percentage of the company’s future credit card sales. When a borrower receives cash from a merchant capital provider, he agrees to pay back the cash advance (plus a fee) by allowing the provider to automatically deduct an agreed-upon percentage of his company’s daily credit and debit card sales.

Borrowers with credit trouble or immediate cash flow issues might appreciate that merchant cash advances are fast and easy to qualify for. Seasonal business owners often choose this option to avoid regular monthly payments during slower sales months. Keep in mind, however, that these conveniences may come with a hefty price tag, as merchant cash advances often have some of the highest interest rates of any online loan product.

Business Line of Credit

Perhaps the most flexible form of small business funding available, a business line of credit gives you capital to draw upon to meet a variety of business needs. Once established, you can draw on your line of credit as you would a personal credit card: to get more working capital, buy inventory, handle seasonal cash flows, pay off other debts, or address almost any other need.

Creative Funding Sources

Although equity and debt are the two most common funding options, they’re not your only choices available. Every day, business owners work within their networks to come up with creative funding solutions that avoid handing over shares in their business or paying expensive interest rates to a lending institution.

Of course, even the most creative funding solution will have its own downsides, which can often be more subtle and emotional than monetary. As you consider these more creative options, don’t underestimate the work or relationship stress that may be caused from involving your close network in funding your business.

Friends and Family

If you’re fortunate enough to have family members or friends in a position to help finance your business, this can be a great way to avoid many of the costs associated with more traditional funding options. Because of your personal relationship, your friends or family members are likely to offer more comfortable terms on a loan or an investment agreement than you’d receive from an angel investor, bank, or online alternative lender.

In the best of circumstances, an investment or loan from a family member or friend can be a beneficial opportunity and a positive experience on all sides. Yet you needn’t look far to find a war story or two of broken relationships between family members or close friends as a result of a business arrangement that didn’t turn out exactly as expected.

Because you know and trust one another, it’s easy to rush forward on a funding agreement without considering all the possible outcomes or clarifying each party’s needs and expectations. This leads to animosity down the line if the business venture doesn’t turn out as anticipated or one person’s expectations aren’t met.

To avoid the heartache of a strained relationship, take steps to outline your funding agreement as explicitly as possible before any money changes hands. If you’ve agreed to a loan, write out terms for exactly how the loan will be repaid, in what increments, and over what period of time. If your friend or family member is making an investment in your business, clarify the exact percentage of ownership or profit share that person will take, as well as the role your investor will have in business decisions moving forward.

Even if you don’t involve an attorney, put the terms in writing and have each party sign so there are no questions later on about exactly what was agreed upon.

There’s no doubt that if funding from friends or family is available, many will choose this path as the fastest, safest, and most cost-effective way to fund a business. As long as you approach the matter respectfully and professionally, there’s no reason that funding through friends and family can’t be a great solution to your business needs.


Crowdfunding has been around for awhile, but until recently it hasn’t been viewed as a business financing solution. Many have seen crowdfunding as primarily meant for charities or creative types. But that image is changing fast as more and more small businesses successfully obtain financing through crowdfunding platforms.

If you’re not familiar with crowdfunding through platforms like Kickstarter or IndieGoGo, the concept is basically that you’re obtaining a larger amount of funding through small contributions from a group of people. You share your vision for what you’ll do with the funds, set a funding goal, then use social media and other marketing avenues to encourage would-be donors to support your campaign.

Of course, the challenge of crowdfunding is actually finding willing participants ready to hand over cash toward your business vision. Crowdfunding experts recommend that you encourage support through incentives—ranging from your heartfelt thanks, to first looks, discounts, or even pre-sales of your product. If you’re starting a restaurant, for example, you could offer tickets to your launch party as an incentive for a certain level of donors.

Keep in mind that crowdfunding requires that you have a certain fan base in place before you start, so it’s typically not a great fit for brand new business owners who don’t have a solid network or customer base. And because most crowdfunding platforms work on an “all or nothing” basis—that is, you must reach your funding goal to receive any cash at all—it works best for those with more modest funding requirements.

Decide How to Fund Your Small Business

Now that we’ve reviewed many of the options you might consider when finding your business, how do you decide which of these is best for your needs?

As the owner, only you know all the ins and outs of how your business works, what your goals are, and what you need to get there. But as you weigh your options and make your decision, here are a few factors that may help direct your choice.

Your Funding Needs

To some extent, the avenue you take to fund your business will depend on how much capital you need. For example, venture capital firms typically make a minimum investment in the millions of dollars, and angel investors generally want to fund projects of at least six figures. If your business needs a relatively small amount of capital in order to grow, these equity funding options may be automatically ruled out because your capital needs don’t match their minimum requirements.

Likewise, among the various small business loan options available, the size of the loan you need might help direct you towards a certain product. The SBA microloan program, for example, is a great option for businesses in need of less than $50,000 in capital—especially those owned by women or minorities.

And within the alternative lending space, you may choose between a short-term loan with a daily or weekly payment schedule and a longer term loan with monthly payments, depending on the amount of cash your business needs and how quickly you’ll be able to repay that principal plus interest.

Your Customer Base

Occasionally, a business’s customer base will drive the decision for how to pursue small business funding. If you operate a small business with a very loyal fan base, your customers themselves may be willing to do their part in funding your expansion.

For example, a popular small town restaurant that finds itself often crowded with local fans could start a crowdfunding campaign on Kickstarter to raise funds for an expanded facility or second location. If patrons love the restaurant but are tired of waiting for a table, many might be willing to contribute to its expansion.

Your Long Term Goals

When choosing the best funding option for your business, it’s important to take a long-term perspective. Instead of looking exclusively at your immediate cash needs—in the next six months to a year, for example—think about where you want your business to be in five to ten years, or even longer.

Who will your competition be? What kind of growth do you hope for? Would you like to eventually sell your business? If you take a longer term view, and can build a viable plan to support it, this may lead you to a larger scale, longer-term funding objective for your business.

Also consider what types of non-financial support you may need to achieve your business goals. An angel investor or venture capital firm can provide valuable expertise and mentoring through their outside perspective and years of experience. And because they own a stake in your business (and therefore in your profits or losses), an investor is likely to do whatever is in their power to help you succeed.

Your Current Financial Reality

Within the realm of debt financing, your funding options can be limited by your current financial reality—and especially by your personal and business credit history.

While your long-term goals may direct you to a larger long-term loan, it may be that your business can only qualify for a smaller, shorter-term loan for the time being. In that case, you may need to take the short-term loan to get your venture off the ground while you build up the credit you need to qualify for a larger loan.

Your Time Constraints

Similarly, if you’re in a hurry to obtain small business funding due to tight cash flow or the need to jump on an immediate opportunity, you may find yourself choosing whichever funding option can get you the cash you need fastest.

This will generally rule out most equity financing options, which often have a lengthy vetting process, as well as any SBA or traditional bank loans. Crowdfunding campaigns usually take a month or two to set up and run, and are not guaranteed, so that option may be out as well. By process of elimination, if time is an issue then you’ll likely hone in on either financing through friends and family (perhaps through a short-term loan while you’re pursuing other options), or an online alternative loan.

Unfortunately, there’s no magic formula to tell you how to fund your business. The decision you make will ultimately come down to a number of very personal factors. But we hope this information will help you feel more informed and empowered to make the right choice for your business needs, both now and in the future!

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