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How to Finance Your Small Business

You have a great idea for a business. You’re passionate about the concept and you want to make it a reality. Yet, how do you get the money to make it happen? Acquiring business funding is one of the most important, foundational pieces of entrepreneurship. It is critical to make smart, well-considered choices to set your business up for success. Knowing exactly how much money you need, what kind of small business loans are available to you, and what lenders expect from applicants will help you score the cash you require to start and grow your business.

What are Your Business Funding Needs?

Starting a business is hard enough, but without adequate financial resources, it’s almost impossible. To ensure you have enough money to get a foothold, entrepreneurs must estimate their business funding needs before starting a company. Consider what one-time startup costs you will incur (like purchasing manufacturing equipment) as well as recurring expenses (like rent and utilities).

Do thorough research so your numbers are as exact as possible; a ballpark range will not do. When in doubt, overestimate the cost of something. The popular adage says things will cost twice as much and three times as long as you think! Keep in mind that it could take years for revenue to catch up to costs. It is prudent to raise enough money at the start to tide you over until you’re in the black.

Create a Financial Plan for Your Business

Once you have a clear picture of your expenses, it’s time to calculate your estimated revenue. Talk to similar, local businesses and others with experience in your market to approximate your potential income. Understand that your numbers will be significantly lower in the early days as word spreads about your business. Mistakes will happen and they will cost money. This is a natural part of the entrepreneurial learning process and you’ll need to budget accordingly.

While weighing your estimated expenses versus revenue is a good place to start, understanding certain aspects of your business can help you get an even more precise picture of your financial needs.

There are different types of business funding that are geared towards the needs of businesses that experience hot and cold seasons. Starting a business is inherently risky, but some types are riskier than others. Certain business financing options can help you plan for risk. It’s prudent to have an emergency financial plan in place so you don’t have to scramble for money under pressure. Market conditions can affect your ability to get good financing terms. They will also impact your company’s revenues.

All investments in your company should have an underlying purpose that helps you meet an objective. Lenders will demand to know your specific intentions for any money they give you. The length of time it will take you to pay back your lenders will have a bearing on the type of small business funding you should target, as will the investment’s usable life. You don’t want to be making payments on something you got rid of years ago. Ask yourself the following questions when creating your financial plan.

  • Do you have a business plan?
  • Is your business seasonal or cyclical?
  • What is your financial plan to ensure you can maintain operations year round?
  • What kind of risk is involved in your business?
  • What is your comfort level for risk?
  • What’s going on in the market?
  • How is your industry performing?
  • Where do you want your business to be in three to five years?
  • How will your startup capital help you achieve your goals?
  • Are your business funding needs long-term or short-term?
  • How long will your investments last before they need to be replaced?

Choosing the Best Small Business Funding Option

Depending on your unique business funding needs, there are a number of options to consider:

1

SBA Loans

These are traditional loans guaranteed by the U.S. Small Business Administration to encourage banks to work with small businesses. With flexible terms and low rates, SBA loans are ideal for existing small businesses looking to grow. It can be difficult to qualify for an SBA loan if you do not have at least two years’ operating history.

2

Long Term Loans

  • Long term loans are a type of debt that is paid off at a regular interval (usually monthly) over a set time frame. Long term loans can extend as long as 30 years or more. These loans feature comparatively good interest rates, though, they can be challenging for a new business to obtain.
3

Short Term Business Loans

  • Short-term loans are similar to long-term loans in their structure. The difference is that they must be paid off in a shorter time frame – usually 3 to 18 months. However, some lending companies will allow terms to stretch to 5 years. Interest rates are higher than competing options.
4

Business Line of Credit

  • Unlike a term loan, which provides a lump sum of money upfront, a business line of credit offers a maximum sum that a business can borrow against as needed. Business lines of credit are ideal for one-off opportunities or emergencies like purchasing discounted inventory or bridging a gap in cash flow. One of the biggest benefits of a line of credit is that the business only pays interest on the portion it has used.
5

Working Capital Loans

  • A working capital loan is a short-term business loan with the express purpose of funding day-to-day operations. This option is ideal for seasonal businesses or those with cyclical sales. Working capital loans are generally easy for small businesses to obtain if they have collateral. Since they have shorter terms, their interest rates are on the high side.
6

Equipment Financing

  • Equipment financing lets a business purchase pricey equipment, like commercial machinery and vehicles, by paying it off little by little over an agreed-upon time period (plus interest). The benefit is there are no barriers to this type of loan. In other words, a business doesn’t need to have good credit, a long operating history, or valuable assets. The equipment itself is used as collateral. So, if the business defaults, the lender can repossess the equipment and sell it to make up the loss.
7

Accounts Receivable Financing

  • Also known as invoice factoring, accounts receivable financing lets a business sell its outstanding invoices to a factoring company for money upfront. The factoring company then collects on the invoices. This is a low-risk lending option for businesses that need immediate access to cash.

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What Factors Affect Your Ability to Get Business Funding?

There are a number of elements that impact your business’ ability to secure financing. These variables, unique to your company, will help determine which business financing option is the best fit.

  • Business History: In many cases, traditional bank lenders won’t work with a business that is less than two years old. Lending companies want to see evidence that a business has a good track record for profitability and success before they take a risk on a new company.
  • Personal Credit History: Since most new small businesses haven’t been around long enough to build a robust business credit history by the time they need financing, banks will refer to the owner’s personal credit history instead. They use this to gage your ability to responsibly manage your finances and deal with debt.
  • Business Credit History: If your business has been around long enough to build its own credit history, it will be the principal element lenders review when determining whether to work with you. Your business credit history includes information like your business’ credit score, how much debt you have presently, what your credit limits are, and how promptly you pay your bills.
  • Existing Assets: Without a lengthy operating history, new small businesses are viewed as chancy investments by many lenders. As such, you may be able to get a loan or better terms on a loan if you have valuable assets to use as collateral.

These can include personal assets like your home and vehicle, as well as business assets like commercial machinery and property. If your business defaults, the lending company will be able to sell these assets to recoup some of the costs. This makes the investment less dubious.

  • Strength of Team: Lenders are interested in the credentials of your management team. They want to see individuals with strong track records for success in your industry.
  • Depth of Business Plan: Not only will a well-thought-out business plan impress potential lending companies, it will set your business up for success. Investors want to work with businesses that have really done their research and know what they’re getting into. A thorough plan that includes detailed financial information will poise your company for business funding triumph.
  • Projected Revenues: One of the most obvious things lenders need to know is whether or not you have enough money coming in to make the payments on your loan each month. They examine your debt-service coverage ratio, which equates the available cash you have to service debt.