Bringing your small business idea to life takes funding. One of the first tasks you have as an entrepreneur is to figure out how you will finance your endeavor. Getting your startup off the ground may require venture capital from investors, small business loans, crowdfunding, or other moneymaking opportunities. How you finance your company can determine your financial strategy in the future – at least until you repay your debts. Use this guide to tackle smart small business financing through a personalized solution.
10 Types of Small Business Financing
You have many different options when trying to decide how to finance your small business. Some of the basic opportunities may first come to mind, such as a small business loan or securing investments. Yet there are several other choices you may not know of, such as factoring or state grants. Read about each potential option thoroughly before making your decision. Each will have pros and cons. Here are 10 of the most common options:
Self-funding your small business puts you in the best place financially, since you will not owe anyone interest or start off indebted to someone else. If you start a business with enough capital in a savings account, you won’t have to repay anything. Consider tapping into your 401(k) or selling some of your assets to gain working capital to start your business. You may also be able to partner with someone else who can split the startup costs with you. Just make sure if you self-fund that you have enough to cover the costs without going bankrupt.
2. Sales revenue.
If you already have a successful business, use available sales revenue from that business to fund your new venture. You could also use sales revenue from customers you already have lined up, if they are willing to wait to receive end products. Using existing sales or income gives you all the benefits of self-funding without having to drain your savings accounts. Business growth may be slower with this strategy, but you will not have to pay back a loan.
3. Family and friends.
Turn to family and friends for loans before you turn to banks. Family and friends will most likely give you a better deal on interest – or, if you’re lucky, not charge interest at all. However, borrowing money from people you know can present problems, such as friends trying to become board members of your business or have a say in decision making. Draw up an actual contract with clearly defined repayment terms to avoid issues down the road.
4. Small business loan.
A small business loan is best for startups with few assets and moderate annual income. Obtaining a small business loan involves proving to a bank that your company is a good investment. You will need to establish your revenue, income generated, business plan, number of employees, and some type of collateral for the loan. Learn more about small business loans through the Small Business Administration.
5. Credit cards.
Although it may be possible to max out credit cards to fund your small business, this is a risky route that should be a last resort. You can destroy your credit score and end up with thousands of dollars in interest payments and penalties if you fall behind on your payments. Paying off just the minimum can create a hole of debt you are stuck in for years. Using credit cards responsibility, however, may be able to help you escape the occasional cash flow crunch.
Investors believe in your business and want to help you by lending you money. You need to win over investors by demonstrating your company’s ability to survive economic downturns and rough patches. First, research investors or venture capital firms to find one that is reputable. Share your business plan with the investor, and cooperate with the due diligence review of your company. If the investor bites, work out the terms of the investment. Note, however, that venture capital investors may become actively involved in your company. You should at least keep investors in the loop when you make major changes or sales.
7. Peer-to-peer lending.
This type of loan is easier to get than a small business loan, and generally has lower interest rates. This loan goes to your personal accounts rather than business accounts. You need a good credit score to qualify for this type of loan (around 640 or higher). The maximum amount you can typically receive through a peer-to-peer loan is $25,000.
Crowdfunding uses funds from a large group of people who do not expect financial returns on their investments. You can start a crowdfunding campaign on many different sites, often for free, and pitch your passion project to the masses. If people are intrigued, they will contribute to your startup by giving you funds. You can then repay these crowdfunders with a product or service once you’re up and running. Unlike typical investors, crowdfunders will not have a say in how you run your business.
Factoring can get you cash up front to help cover the costs of running your business. You can sell your accounts receivable to a factoring company for cash up front, rather than waiting for your customers to pay their invoices. Factoring is most appropriate to cover gaps in cash flow, especially if you have a lot of outstanding accounts receivable. One of the cons, however, is that most companies charge a fee that equals a percentage of the total amount.
State and federal grants may be available to help start your business. You do not need to repay grants, making them an excellent source of startup capital. The Small Business Administration establishes certain size standards for different industries. If you meet these standards, you could qualify for a small business grant through a state or federal government agency. Start by at your state’s Small Business Development Center. This is a network of sites that can give you advice on how to finance your business. It may have information about available grants.
Obtaining funds for your small business takes looking in the right places, as well as knowing your goals and current financial situation. Establish your goals for your startup. Then, analyze the current sources of capital that may be available to you. Look at your credit score, personal financial history, and business expertise. Then, assess your ability to pay back a loan. Assess interest rates you might receive based on your credit history. Research the key differences between sources of funding to make an educated decision moving forward.
How to Successfully Manage Repayment
If you use a common strategy that requires repayment of an investment or loan, map out a strategy on how you will repay what you owe. Planning exactly how and when you will repay your debts can help you avoid significant issues such as owing thousands of dollars in interest or missing payments and suffering penalties. Knowing exactly what you are getting yourself into can inform your business strategy for the future and let you proceed with confidence. Here’s how to tackle loan repayment:
• Calculate interest rates. Before you sign on for a loan, find out your interest rates. These can vary significant depending on your credit history and the terms of your loan. Understand the predetermined interest rate on your loan and factor it into the total amount you will owe the bank or investor.
• Understand the terms. Read the fine print on your loan documents. One of the most important terms to know is how long you have to repay your debt. Some lenders may have a deadline, while others do not. Even with an imposed deadline, however, you should map out exactly how long it will take you to pay off a loan. This can inform your financial management for the future.
• Sign up for automatic payments. Most loans require monthly payment installations until you have paid back what you owe. If you can, schedule automatic payments to banks or lenders. Automatic payments sometimes come with perks such as lower interest rates. It can also protect your credit score and save you money in penalties by preventing late or missed payments.
• Master financial management. Create a strong business plan that includes how you will manage your company’s finances for at least the next 12 months. Draw up a budget that includes any payments you need to make on loans as one of your expenses. Stick to your budget to repay your debts without sinking the company. Having a smart financing plan can expose opportunities to save money.
Have a plan for how you will manage repayment before you ever agree to financing. Look toward the future when deciding which funding option to accept. Choose the option that will work best for your startup in the long run. If you need assistance setting up your company, creating a business plan, mapping out cash flow, or managing other money matters, contact Diversified Management Services, Inc.