How to Fund a Business: Every Step You Need to Take
All businesses — from startups to well-established companies — will need financing at some point. One of the biggest challenges facing small businesses today is acquiring enough capital to grow the business. It’s sometimes difficult to understand how to fund a business — and where to get the funds.
Startups should consider whether they’ll operate strictly online, have a brick-and-mortar location or require warehouse space. Both startups and established businesses should have a firm understanding regarding total costs, such as office space and equipment, inventory and even employee salaries. Below are a few common reasons a business might need a loan:
- Cash flow needs
- Finance equipment
- Purchase real estate
- New construction or upgrades
Once you have a solid idea of how much money your business will need, you can start to narrow down the funding solution that’s right for you. Some loans are larger than others, and all come with different repayment terms and interest rates and fees.
So let’s dive in and learn exactly how to fund a business.
Evaluate business funding options
There are many options to get funding for your business. You can secure small business loans from a traditional bank or from an alternative, online financial institution. You can also get funding from grants, investors or crowdfunding. Review these different funding solutions and choose one that works for your business.
Term loans are either secured or unsecured. In general, secured loans come with less stringent requirements because you use an asset to secure the loan; however, the requirements ultimately depend on the lending institution and borrower. According to Bank of America, an unsecured term loan requires less in annual business revenues and a secured loan requires more in order to qualify. It’s also common for an unsecured term loan to come with lower borrowing limits.
A secured loan requires collateral to qualify, but also comes with a higher borrowing limit. As a result, the unsecured term loan might be more appropriate for low-cost operations or for working capital. Secured term loans might be more appropriate for larger business needs, such as purchasing a fleet of trucks.
To acquire a term loan, your business must typically:
- Have been in business for at least two years
- Generate $100,000 in annual revenue if you’re applying for an unsecured term loan
- Generate $250,000 in annual revenue if you’re applying for a secured term loan.
U.S. Small Business Administration loans are issued through SBA-partnered banks — the SBA guarantees these loans as a way of protecting lenders if the borrower defaults. The most popular SBA loan program is the 7(a), which you can use for anything from startup expenses to company upgrades. There are other SBA loan programs available, however, that are specifically designed to meet the unique needs of a business.
To acquire an SBA loan, you’ll typically need to submit the following documents so the lender can assess your creditworthiness:
- Personal financial statements
- Business financial statements, including balance sheets and profit and loss statements
- Income tax returns
- Loan application history
Line of credit
A business line of credit is another way you can fund your business, and it’s similar to a term loan. An unsecured line of credit might have lower borrowing limits and less stringent qualifying standards. A secured line of credit might have higher borrowing limits, but higher requirements for annual revenues.
To acquire a line of credit, businesses typically must:
- Have been in business for at least two years
- Generate $100,000 in annual revenue for an unsecured term loan
- Generate $250,000 in annual revenue for a secured term loan
Business credit card
A business credit card works like a traditional, personal credit card and often comes with a rewards program. You can use a business credit card anywhere Visa, MasterCard, American Express or Discover is accepted. The best business credit cards come with rewards programs, an introductory period that includes either 0 percent APR on purchases or balance transfers (or both) and additional tools to help you manage your business, such as online spending reports, mobile account management and employee cards. In order to qualify for a good business credit card, you’ll need to submit to a personal and business credit check.
A personal loan is an unsecured loan, which means it doesn’t require collateral. To get a personal loan, you must submit to a credit check by the lender. An excellent credit score, which is 780 or above, will likely qualify you for a higher loan amount and a better rate.
A merchant cash advance is not a loan — think of it as a business cash advance. Under an MCA arrangement, you repay the lender gets by allowing them to directly debit your credit card receipts from your account each day — before your business gets any money from the sale. The advantage of an MCA is that it allows businesses to repay the funds through future sales instead of through a predetermined, fixed amount. That said, these advances are extremely expensive, so use them very, very carefully.
To acquire an MCA, businesses typically must:
- Have been in operation for at least six months to a year
- Make at least $5,000 monthly
A microloan is a small loan that often maxes out at $50,000 — the average microloan amount is $13,000. Microloans are flexible: You can use them to fund equipment, furniture or inventory purchases — or for working capital. You can’t use a microloan, however, to pay down existing debts. Because the SBA secures microloans, their requirements are similar to other SBA loans.
Angel investors are individuals with the resources to help businesses get off the ground — and there are many different types of investors out there. Investors might be wealthy individuals or groups that take an interest in your business. The world of angel investment is diverse, and in many cases, these types of investors don’t expect you to pay them back if your business fails. Angel investors are also likely to realize that any payoff will require a long-time investment.
In a peer-to-peer lending situation, websites partner investors with small business owners to help business owners find funding. Peer-to-peer investment services will still check your credit and financial history, which means it will be hard to secure an investor if you have poor credit.
You might opt for crowdfunding investments — you raise money online by appealing to anyone who takes an interest in your business. You’ll need to put together your business pitch, but keep in mind that individual investors are limited to investing $107,000 every 12 months.
Friends and family
Turning to your friends and family can be a great resource for funding your business. It’s important, however, not to borrow any money without executing a formal contract. The contract will serve as a guide for the financial arrangement, outlining any interest on the funds, payment amounts and due dates.
Venture capital is a form of financing that investors provide typically to startups and emerging firms with high growth potential. In order to acquire venture capital, entrepreneurs often have to hunt for investors — going through an investment company might be a better alternative. The Small Business Investment Company, licensed by the SBA, helps businesses find investors.
Congress and various governmental agencies handle government grants, and they are very difficult and competitive to secure. The government rarely extends grants to traditional small businesses. You also can’t usually use these grants to start a business, pay off debts or cover operational expenses.
It is possible, however, for high-tech or R&D businesses to secure a grant through the government’s Small Business Research or Small Business Technology Transfer programs.
Alternatively, some private companies and corporations issue small business grants. For example, the National Association of the Self-Employed offers small business grants to members for up to $4,000. You should expect these application requirements to differ among organizations.
Choose a lender
After you get familiar with all the funding types available for your business and understand which financing option you can qualify for, it’s time to look at lenders. Each lending option has its own pros and cons.
Traditional lenders are usually thought of as brick-and-mortar financial institutions. Traditional banks often offer the widest variety of funding options for small businesses, such as:
- Lines of credit
- Term loans
- Auto loans
- Commercial real estate loans
- SBA loans
- Credit cards
- Equipment loans
Banks can often offer the biggest loans to borrowers, too. For example, the SBA has a maximum borrowing limit of $5 million. These big loans, however, come with much more stringent qualifying requirements. The best candidates for traditional bank loans are businesses that have been in operation for at least two years and generate at least $100,000 in annual revenue.
According to the Small Business Credit Survey, credit unions are the least-utilized source of financing for small businesses. Credit unions offer unsecured and secured loans that often come with more favorable interest rates than you’ll find at traditional banks because credit unions are nonprofit organizations. In addition, they tend to be more willing to work with local, community small businesses. Securing a business loan through a credit union is a great idea for credit union members who have established businesses with strong revenues.
Alternative lenders have fewer lending products than traditional banks or credit unions and might not be able to offer as much funding as traditional banks. Alternative lenders, however, are ideal for borrowers who are seeking smaller amounts of funding — these lenders typically offer term loans and lines of credit, but with higher interest rates and fees. One major advantage of getting a business loan from an alternative lender is that the time from application to funding can take as little as 24 hours to 48 hours, which is great if you need funding fast. Working with alternative lenders is convenient, too, because you can typically complete your entire application online, they will likely have more relaxed credit requirements and they tend to be more flexible regarding how you can use the funds.
Get ready to apply
Now that you’ve assessed all the financial options for your business and know where to go to get the funds, it’s time to think about the application process. There are several documents you will need when applying for a business loan or business funding. The SBA provides a checklist of the most common documents required for its 7(a) program, and that’s a good starting point. Some common documents you can expect to provide with your application include:
- A statement of personal history (SBA Form 912)
- A personal financial statement (SBA Form 413)
- Year-end profit and loss statement
- Year-end balance sheet
- Projected financial statements
- Business license
- Income tax returns
- Business history
- Business lease
The time it takes to get approved after you submit your application varies by lender. Traditional lenders might take up to 60 days to review and make a decision on your application. Alternative lenders are known for their fast approval processes, and you might hear something in as few as 48 hours.
As part of their evaluation process, lenders are most concerned with sufficient assets, good cash flow and a profitable track record. They use your application and supporting documents to determine your creditworthiness and your level of risk as a borrower.