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How to Finance a Business, From Startups to Existing Companies
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The funding for financing a small business typically hinges on factors such as time in business, annual revenue and credit scores. If you’re wondering how to finance a business or qualify for business financing options, we’ll walk you through the process depending on how long the small business has been operating.
- How to finance a business
- How to finance a business: Startups
- How to finance a business: 6-plus months to 2 years in operation
- How to finance a business: 2-plus years in operation
How to finance a business
Business financing simply means securing money to run your business. Debt and equity financing represent two broad categories for funding a business.
- Debt financing: You borrow money that you’ll repay from your business cash flow. Debt financing examples include small business loans, lines of credit and business credit cards.
- Equity financing: You raise capital through private investors who receive an ownership stake in your company in exchange. This type of financing, which isn’t a loan, is more often associated with businesses that seek equity funding from angel investors and venture capitalists.
There are different reasons that financing a small business might be necessary. You may need seed money to get your idea off the ground. Or, you may be a year into operations and need to add an employee or two. For more established businesses, financing can help with expansion and continued growth.
Among other factors, time in business matters when seeking financing. There are three broad categories we’ll discuss:
- 0 to 6 months in business
- 6-plus months to 2 years in business
- 2-plus years in business
Where you are on the timeline can influence the type of financing you’re able to get.
How to finance a business: Startups
A startup is a business or company that’s in the beginning stages of operation. Startups often have different needs compared to businesses that have been operating for a year or two (or more).
Deciding how to finance a startup can be challenging for different reasons. You may not have the necessary time in business or revenue to qualify for traditional small business loans. But it’s possible to fund your new business.
Use personal assets or savings
Bootstrapping may be the most obvious option for how to finance a startup. Instead of borrowing money or raising capital from investors, you use your financial resources.
Calloway Cook, president of Illuminate Labs, a dietary supplement startup, said bootstrapping could be a good choice for people who have a stable income and need less than $100,000 to launch their business. “If you need $3 million to launch, then bootstrapping makes no sense,” he said.
There are pros and cons associated with bootstrapping.
- You’re not starting off your business in debt
- You’re not giving up ownership in your business the way you would with equity financing
- You’re putting your personal assets at risk if the business doesn’t pan out
- You’re still going to need to look for other ways to get the capital you need if your assets alone aren’t enough to cover your financing needs
If you’re considering bootstrapping, there are different assets you could use:
- Home equity
- Personal savings
- Certificates of deposit
- 401(k) or individual retirement accounts (IRAs)
Again, there are pros and cons. Tapping your home equity means you’re not using out-of-pocket cash, but you’re creating debt that has to be repaid. If you can’t repay a home equity loan or home equity line of credit (HELOC), you risk losing the home.
Borrowing against your 401(k) or withdrawing money from an IRA means you’re essentially lending money to yourself. But you may trigger tax penalties if you don’t repay a 401(k) loan or take an early IRA withdrawal. And, of course, this means siphoning money away from your retirement.
Use a business credit card
Opening a business credit card is another option for how to finance a business. You could possibly get a business credit card with minimal operating history or business revenue. Your personal credit score and financial situation would be factors for approval.
The advantages of using a business credit card include:
- Convenience to make purchases
- Ability to repay over time
- Chance to earn rewards
- Help with establishing and building business credit, which could help you qualify for other small business financing options down the line
Of course, if you’re carrying a balance month to month, interest charges make purchases more expensive. Some business credit cards also charge pricey annual fees.
Take out a personal loan
You might consider a personal loan for business if you’d rather not use your own assets or a credit card. Personal loans can offer lump sums that can be repaid over a set period at a fixed interest rate. Depending on your credit history, a personal loan may be secured or unsecured.
Getting a personal loan could be a good option if you don’t meet the requirements for a small business loan. You may get a better interest rate than you might with a credit card. Use our Business Loan Calculator to determine how much interest you’ll pay. Just consider how feasible making payments will be until your business begins generating cash flow.
Borrow from friends and family
You could ask friends and family to offer capital to support your business. Borrowing from people you know could be beneficial if they don’t charge you interest. But the relationship could turn sour if you’re not able to repay what you borrow.
How to finance a business: 6-plus months to 2 years in operation
Once you hit the six-month mark in business, your financing needs might begin to shift. If you’re starting to hire employees, you may need working capital to cover hiring costs or payroll until your investment begins to pay off. Finding ways to scale up may also be a priority. The great thing about raising investment capital or getting a loan in place of bootstrapping, said Cook, is that you can focus 100% of your energy on your business, allowing you to grow faster.
These funding options are suited to businesses in this stage of growth, although they can also work for older businesses, too.
Get business financing from a bank
According to Federal Reserve data, 73% of business borrowers report being highly satisfied with their lending experience at small banks, while 55% of businesses say the same for large banks. Better interest rates and more favorable repayment terms influenced satisfaction levels.
Banks can also offer a one-on-one lending experience. Your options for how to get financing for a business through a bank include:
- Traditional bank business loans: These allow you to borrow a lump sum to meet different business needs. Loans can be used for short- or long-term goals, including buying equipment, hiring or expanding.
- Small Business Administration loans: The Small Business Administration guarantees these for small businesses offered by partner lenders. Borrowing limits are generous — it’s possible to get up to $5 million in funding through the 7(a) program. SBA loans could be a good fit for businesses with consistent revenues and good credit.
- Invoice financing: This is a way to leverage your outstanding invoices to get funding. It’s a convenient and flexible form of financing for those with poor or limited credit history.
- Business lines of credit: These offer access to a revolving credit line you can borrow against as needed. Similar to a credit card, you only pay interest on the amount of your credit limit you use.
Use an alternative online lender
Online lenders can offer many of the same small business financing options as traditional banks, with a few alternatives. Note that you may pay higher interest rates or fees to borrow online.
In addition to loans, lines of credit and invoice financing, online lenders can also offer the following:
- Invoice factoring: You sell your invoices to a financing company, which takes over responsibility for collecting payment from your customers. This is different from invoice financing, in which you borrow against your outstanding invoices and pay back the loan to the financing company.
- Merchant cash advance: You borrow against your future revenue. The amount borrowed is repaid daily or weekly from your credit card or debit card sales.
Both invoice factoring and merchant cash advances can charge a factor rate rather than an APR. Depending on your terms, either could be more expensive than a traditional loan. The upside is that you don’t need excellent credit to qualify.
Find others to invest
Another option that’s in the in-between stage is seeking out investors:
- Peer-to-peer lending/crowdfunding
- Angel investing
- Venture capital
Peer-to-peer lending (more on this later) is debt financing, so you’re not trading equity for funding. Crowdfunding can be equity- or debt-based, while angel investors (more on this soon, too) and venture capitalists typically expect equity in return for their investment. Whether it makes sense to consider these options may depend on how comfortable you are letting go of some of the ownership control of your business.
Get a small business grant
Small business grants are a way to get capital for your business without creating debt or exchanging equity. Grants typically don’t have to be repaid, but qualifying for them can be challenging. That’s because many grant programs have specific requirements that businesses must meet to be eligible.
Some grants may be open only to women-owned businesses or businesses in certain industries, for example. But it’s worth it to explore grants for how to finance a business if you’d rather avoid debt or equity financing.
How to finance a business: 2-plus years in operation
Your options for how to get capital for a business that’s been operating for 2-plus years encompass many of the same financing paths available to younger businesses. At this stage, your needs may be more focused.
Leverage invoice financing
Invoice financing, as noted, means borrowing against your outstanding invoices. This kind of financing is typically better suited to meeting short-term working capital needs.
Invoice financing or factoring may be a good choice for a mature business if the owner doesn’t have strong business credit. It’s important to consider the cost of borrowing, however, since invoice financing could be more expensive than other loans or lines of credit.
Angel investors are business owners who’ve been successful and want to pay that forward. If you have an established business, angel investors — which Cook used for his startup — could provide hundreds of thousands or millions of dollars in funding. Again, though, you may be granting an angel investor some form of equity in your business as a condition.
Peer-to-peer lending is a way to raise capital from private investors without making the equity trade. When you borrow through a P2P platform, investors are pooling money together. They make a return on their investment through the interest you pay on the loan. The trade-off is that P2P lending may allow you to access lower amounts of capital compared to that provided by angel investors.
Borrow from a nonprofit
Nonprofit business organizations can offer funding to businesses in the form of microloans and term loans. The SBA’s microloan program, for instance, offers up to $50,000 in funding for businesses that have smaller capital needs.
In addition to the SBA, you may be able to find funding through nonprofits in your local area. These organizations may be specialized and cater to certain groups of individuals, such as minority-owned businesses, so it’s important to do your research.
Crowdfunding platforms such as GoFundMe allow businesses of all types to launch a platform and raise capital. The advantage is that you can raise awareness and visibility for your brand while getting money. Crowdfunding may also be a faster path to funding than getting a loan or line of credit.
Keep in mind is that crowdfunding can be competitive. There are lots of businesses vying for investors’ attention and money. So if you’re considering this option, do your homework first to learn what goes into a successful crowdfunding campaign.