Financing is one of the most confusing aspects of starting or growing your business. There are a lot of directions you can go, all with positives, negatives, and different responsibilities.
In this small business financing guide, we’ve tackled some of the major financing options available to most small businesses. These are great tools for both starting a business, and taking it to the next level.
Keep in mind while you’re reading this guide that just because you choose one method of financing doesn’t mean you can’t complement it with other options.
Let’s dig in!
Pros of self-financing
No interest payments
Complete control over your venture
Cons of self-financing
High personal financial risk
Many don’t consider self-financing as an option if they don’t have the cash on hand to make a dent in their start-up costs and initial operating expenses. But even if you don’t have the cash, it doesn’t mean you don’t have assets that can’t be reinvested.
This could be as simple as selling valuables you don’t need, drawing from your retirement account, or pulling money from other liquid investments such as stocks or bonds.
Some of the most popular forms of self-financing include:
Home equity loans
These low-interest rate loans leverage the money you’ve already paid into your home mortgage and provide you with either a lump sum or line of credit in this amount.
This is a risky option however, as if you fail to repay your loan, you will likely lose your home. This puts a lot of pressure on your new business and your personal financial picture.
For those with a large savings account, financing all or part of your small business via these funds can be an excellent option. When using your personal savings, you’ll avoid paying interest rates and will ultimately spend less than taking out a loan.
If you do go this route, we always suggest keeping enough savings available to pay for unexpected expenses that may pop up in your personal life.
While it’s hard to completely self-finance a small business with a credit card, they’re a great resource to supplement other forms of financing.
Paying for day-to-day expenses, unexpected costs, supplies, and equipment can ultimately help you not overburden your other financing sources. You can then pay of these expenses as cash flow starts coming in. Just remember to always pay the minimum payment on your credit card statement!
Small Business Loan
Pros of small business loans
Retain control of business
Less personal risk
Cons of small business loans
Difficult and lengthy application and approval process
Interest payments and repayments on principal add up and put pressure on profit
Traditionally, small business loans procured through a bank were the best and easiest way to finance a new business.
Times have changed. With the last financial crisis behind us, banks have become more risk averse and have reined in their small business lending practices. There’s now less money available for small business entrepreneurs. And even when they are available, interest rates are generally higher and it can take months to get your loan approved.
These loans are still available and worth exploring (especially through a financial institution you already have a relationship with). Just keep expectations tempered.
While traditional loans may be fading from popularity, there are some small business loans that are still available to small business entrepreneurs.
The SBA, or Small Business Administration, is a federal organization that helps small businesses acquire larger loans than they otherwise might have qualified for. They do this through guaranteeing portions of these loans to the lending institutions, encouraging the banks to offer larger loans.
Many SBA loans have specific requirements that must be met prior to qualification, such as proof that you weren’t able to achieve a loan through any other means.
It is incredibly important for SBA loans that your paperwork is in order when applying. Make sure to read the SBA’s Loan Application Checklist before submitting any paperwork.
Also known as “micro-loans,” short-term loans provide fast capital to businesses to allow them to grow their venture.
Micro-loans do away with the excessive documentation and approval process of a normal business loan. These loans are often approved quickly and deliver the cash you need in as little as 2 days.
While the speed of these loans can make them a fantastic tool, they also have downsides. Generally, these loans have to be paid back in 12-18 months and have higher interest rates than other types of financing.
Borrowing from friends and family
Pros of borrowing from friends and family
Likely lower or no interest rate
More forgiving creditor
No application process
Cons of borrowing from friends and family
Potentially fractured personal relationships
Limited credit extended
A potentially risky financing option, though one with a high upside, is borrowing money or selling equity to friends or family.
Friends and family are going to be more lenient and forgiving than a bank, and also will likely have more belief in your concept. Your existing personal relationship will provide a foundation for a potentially prosperous business relationship.
Of course, the opposite can be true, too. If things do go south, your personal relationship could falter due to pressures of the investment not working. To make sure your personal relationship with your friend or family member remains strong, we recommend you:
Be upfront about the risks of investing in your business.
Treat your friends and family as you would any other investor.
Make sure to prioritize repayment to them as you would any other creditor.
Prioritize communication. Be upfront if your business is not doing well and do not lead them on to procure additional funding.
Pros of equity fundraising
Generally no repayment is necessary
Investor has stake in your venture, often offering advice and expertise
More runway available before becoming profitable
Cons of equity fundraising
Loss of control of your business
Potential disagreements between shareholders
Growing more and more popular thanks to the rise of the tech industry, equity fundraising is a form of financing wherein you don’t have to pay back the investment capital you receive. Instead you sell an ownership stake in your company in exchange for funding.
If available, this is a great option for limiting personal financial risk. It’s an especially good option if your business needs some runway before becoming profitable, as there will be no pressure to repay loans.
Some places to seek out equity fundraising include:
Venture capital firms
Family and friends
Of course, equity fundraising does have its downsides. When you sell shares in your company, you’re giving away control to investors who may have a different vision than you do. Make sure that anyone buying shares believes in your vision, is trustworthy, and has good intentions for the direction of your venture.
Pros of crowdsourcing
No cash repayment
Retain control over venture
Could garner brand following
Cons of crowdsourcing
Difficult to build campaign that catches on
Must deliver promised products, services, or prizes offered to raise money
A recent financing trend for B2C small businesses is crowd sourced fundraising.
Crowdsourcing, which is particularly great for product-lead ventures, involves raising money through a pre-sale. First, you set a fundraising goal on a platform such as Kickstarter or GoFundMe. Supporters of your product then “invest” by buying products, services, or other rewards. These are then delivered once production of your product has begun or your service-based business is up and running.
If your campaign catches fire and your product connects with investors, this is one of the better options for fundraising. You do not have to pay back your money (other than delivering on what you’ve offered) and you’re not surrendering control of your company.
Just make sure to be responsible with your cash so you can deliver what you’ve promised.
Are you getting the advice you need to start and grow your business?
At Opsahl Dawson, we help businesses of all sizes grow their ventures and realize their potential. Whether you’re just starting out and need help getting up and running, or are just looking for help reaching your maximum potential, we can advise you on how to be all you can be.
Our CPAs are the best in Southwest, WA and love working with local businesses. Contact us today to see how we can help take your business to the next level.
By opsahlco|2019-05-16T16:23:11+00:00May 16th, 2019|Finance|Comments Off on Small Business Financing Guide