How to Finance a Small Business

Starting a business costs money. Therefore, the first and most fundamental decision you must make when starting a new venture is how to finance a small business. Everything from the structure to the operation of your business depends on these essential financial decisions.

When considering how to finance a small business, you have many options, most of which break down into four categories:

1. Self-funding
2. Loans
3. Investors
4. Gifts
   

Self-funding

Also known as bootstrapping, funding your business involves leveraging your financial resources to build it and keep it afloat until it can support itself (and, ideally, you.)

There are many ways you can attain capital this way, including:

1. Using your savings
2. Tapping into a retirement fund like a 401(k) or IRA
3. Taking on a second or side job or getting a raise at your current one
   

The main advantage of funding your small business is that you’re beholden to no other individuals or entities regarding how you run the business, and no one claims a share of your profits. You keep complete control over your small business and only reap the benefits.

The main disadvantage of this method of financing your small business is that you alone also take on all the risk.

Self-funding Tips

Avoid spending more on your small business than you can reasonably afford.

Before taking money out of any retirement account, understand the risks and costs involved, such as delaying your retirement and incurring fees and penalties from early withdrawal.

Loans

When many think of starting a small business or raising capital for an existing one, they often consider getting a small business loan.

You can have several advantages if you qualify for a small business loan. Most significantly, you can gain quick access to money to take actions now that can help determine the direction and progress of your business and propel it forward.

There are some risks and drawbacks of taking out small business loans too, however, that you must also remain aware of. Loans typically incur interest you must pay back on top of the principal you borrow, and the lower your creditworthiness, the higher this interest rate can be. This is the trade-off for getting that money now instead of when you may earn or acquire it some other way.

In addition, other fees may be involved in taking out a small business loan, such as a loan origination fee or even an early payoff fee. The new loan also affects your credit score and can limit your access to future funds should your small business face a real emergency.

Tips for Getting a Small Business Loan

Do your homework. This includes preparations for finding a lender and submitting your loan package.

Search for the right lender for you and for a loan that meets your actual needs; these include the ability to practically and realistically meet your end of the agreement. When searching for lenders, make sure the loans are FDIC insured. Some small business loans are guaranteed by the U.S. Small Business Association (SBA.) With these SBA-guaranteed loans, the SBA will agree to guarantee a loan a bank gives you if it is too reluctant to give it to you.

Visit the SBA to learn about other sponsored small business lending programs for businesses, like those involved in particular enterprises, including:

1. Small Business Investment Company (SBIC)
2. Small Business Innovation Research (SBIR) program
3. Small Business Technology Transfer (STTR) program
   

Don’t forget to look at credit unions in addition to banks; credit unions can often offer you even better terms and lower barriers to entry than banks. A proliferation of online lenders is also now available.

Each type of lender is better for different types of borrowers. Banks, for example, are better for already established small businesses with solid credit and collateral to offer in exchange for the risk the lender is taking on; an SBA loan, in contrast, is better for newer businesses or startups that fall short of qualifying for more traditional lending sources, like banks. Meanwhile, online lenders are better for businesses and business owners with shoddier credit who need fast and easy access to cash without any needless delays or hurdles.

Just be sure whomever you use as your lender that you read the fine print of any document, ideally with your small business lawyer, before you sign it.

Once you’ve found the right combination of lender and loan, create an impeccable package that makes an irrefutable case for why your business deserves that loan. These should include a clear and well-thought-out business plan, a thorough expense sheet, and financial projections for the next five years.

Investors

Getting business funding from investors, also known as venture capital, involves an exchange of value. Your investors give you money to help fund your business in exchange for some ownership or share of its profits.

Different investors may be willing to invest in businesses in different stages. Some investors may only invest in established businesses with a proven track record, while others may invest primarily in early-stage startups.

Some investors want a say in how you run the business and any important business decisions you make that may affect their investment. Many will expect a seat on your board of directors. When accepting funding from investors, you must prepare to relinquish some measure of ownership and control over your business. Be aware, as well, that working with investors tends to involve a longer time horizon than other, more traditional forms of small business financing.

Investors typically choose which businesses to get involved with based on specific criteria. Often investors seek out high-growth businesses to provide venture capital in exchange for some equity. They’re often willing to take on greater risk in trade for potentially more significant returns.

Angel investors, for example, tend to be wealthy individuals who take no claim on the business's assets and, therefore, generally expect a position of ownership.

One of the significant side benefits of working with venture capital is the other resources besides financial that they bring to the table. If you pick the right ones, venture capitalists often have expertise in the areas in which your business is involved and experience taking the actions it needs to take next, such as how to increase average spend per customer. These, in turn, can help you increase your earnings, making you more able to pay off your obligations and reduce how much you need from outside sources.

Tips for Using Investors

Before you accept an investment from anyone, be sure you understand and agree to the terms. Does the investor expect their capital returned, and if so, according to what circumstances and conditions? Does the investor want a portion of your profits, and if so, how much? Or does the investor want to influence how the business is run? And what happens to their investment if your business fails? Outline all these terms on paper, ensure you agree and give them your signature.

How to Obtain Investments in Your Business

1. Locate an investor.
2. Provide your business plan.
3. Perform your due diligence.
4. Determine the terms.
5. Obtain the investment.
   

Gifts

One common way to get money for a small business is to ask friends and family for donations. Many people who love you will love the opportunity to support your business.

You don’t need to stop there, however.

Crowdfunding

Thanks to the internet, you now have a new way to receive monetary donations to your business known as crowdfunding.

Through crowdfunding, you can post information about your business, its vision, prospects, and needs and incentivize others to contribute to the success of your enterprise.

Rather than monetary incentives, however, these incentives are generally gifts you develop that are relevant to your business. These could be anything from company merchandise to free or discounted products or services to the contributors’ names associated with those products or services to one-on-one site-downs with company executives.

The benefit of this method is that it poses very little risk to you, the business owner. It costs almost nothing to put the word out about your crowdfunding intentions; many platforms exist with low fees or even take a percentage of your take only if you make money—research to find out which crowdfunding platforms are available today and what fees they involve.

If your crowdfunding efforts fail, you’ve lost next to nothing, and if they succeed, your only obligation is to make good on the promised incentives you offered for that aid.

Grants

When starting a new venture, the biggest challenge is how to finance a small business, and one of the best ways to get funding is through small business grants. In the case of most grants, however, the exchange you offer is not in the form of gifts; instead, it comes in the form of meeting certain standards of practice or completing specific business goals or projects.

Many individuals and entities offer small business grants, from non-profit to government organizations to for-profit corporations. You need to research which grants are the right match for you. You can start by checking out your local Small Business Development Center or Economic Development Administration. Grants.gov is also a valuable source of public and private grants.

Presenting a Good Image Can Increase Your Chances of Getting Funded

However you decide to pursue how to finance a small business, you'll need to present a clear and attractive image and message: to potential lenders, investors, givers, and ultimately customers. This includes close and careful attention to how you design and manage your website. Contact us for expert aid in optimizing your small business website design and management. By better managing your existing business capital, you'll have less capital you'll need to worry about financing in the first place. Whatever capital you need, your website will be one of your primary assets in helping you obtain funding.