Planning Your Small Business Funding
The new year is a popular time to make personal goals and resolutions. It’s also a great time to focus on business goals and plans for the 12 months ahead. As you clear the holiday clutter and open a fresh calendar, consider what achievements you have in mind for your business this year and what steps you need to take to reach them.
Tips to kick off the new year
If you are aiming to begin new business initiatives in 2018 or to take on any type of growth, an important aspect of your preparation will be financial planning. As you begin the new year, consider these suggestions to get you started on the right foot financially.
Understand cash flow
“Cash flow and seasonality is a really big issue,” said Jeffrey Bumbales, from Credibly, a provider of small business loans and working capital financing. “Your cash flow determines what you have available in terms of working capital. That’s going to dictate what you do and how you plan.”
Performing a cash flow analysis can help you immensely in understanding what your business can comfortably afford. It can also help you identify trends in seasonality, which can impact project timing.
To conduct a cash flow analysis, document the financial inflow and outflow of your business for a set period, focusing on operations, investing and financing activities. By subtracting the total outflow from the total inflow and comparing it to the balance at the start of that period, you’ll determine whether or not you have positive cash flow.
Check your business credit scores
Your business’ credit score can mean the difference between loan approval and denial. It can also be the key to scoring attractive terms with suppliers. David Nilssen, CEO of small business financing company Guidant Financial, recommends that companies check their credit scores to determine which types of funding may or may not be available to them in the coming year.
To check your business credit scores, visit the websites of the three business credit reporting agencies (Dun & Bradstreet, Equifax and Experian) and order a score report. Alternatively, you can engage with a business credit monitoring service that will regularly pull and monitor your scores.
“January is the time to start researching options,” Nilssen said. If it looks like your credit score is not high enough to obtain a traditional small business loan, start looking into other possibilities, such as personal financing or options available from alternative lenders.
No matter what the future holds for your company, it’s good practice to have all financial documents complete and organized. If seeking funding is in the cards, it will be essential to submit important tax and business documents during the loan packaging process, according to Nilssen.
To ease that burden during application, start compiling the proper paperwork now, including:
- Business plan, including projections
- Recent bank statements (both business and personal)
- Recent tax returns (both business and personal)
- Profit and loss statements
- Balance sheet
- Income statement
- Proof of collateral
- Proof of equity investment
- Business licenses and registrations
- Franchise paperwork (if applicable)
- Existing purchase agreements and contracts with third parties
- Articles of incorporation or partnership
Most importantly, ensure you can communicate how much financing you need, how you plan to apply it and how you intend to pay it back.
Resolving to spend and save responsibly in the new year can positively impact your other business goals. “You need to have a nice cushion so that when you’re taking on new initiatives, your business isn’t going to be constrained to maintain business continuity,” Bumbales said. Nilssen advocates focusing any auxiliary funds on paying down existing debt before embarking on new projects. Not only will doing so help eliminate your debt burden, but it can positively impact your credit score.
Types of small business funding available
Once you’ve determined you’ll need outside financing to reach your business goals, it’s time to decide which type will work best for your company.
Working capital loans are short-term business loans used to finance a company’s day-to-day operations during a slow season. They are ideal for things like covering payroll gaps or purchasing supplies, but don’t make sense in situations where a company needs to make long-term investments like purchasing updated machinery or computer systems.
“Working capital loans are ideal for a profitable existing business, or a service-based business looking to do a start-up,” Nilssen explained. “This type of financing is great for businesses that are able to get their doors open, but need a little extra capital on hand at first, or are looking to expand.”
Business line of credit
A business line of credit allows companies to draw money as needed from a set amount, compared with traditional loans that involve borrowing a single lump sum. Interest is only collected on the amount borrowed. Business lines of credit are revolving, which means that once you pay off the amount you owe, the full amount is available again.
“Business lines of credit are great for existing businesses with high accounts receivable to help bridge the gap between collecting payment and paying out expenses such as payroll,” Nilssen said. However, not all companies may be able to secure a line of credit. “A line of credit can often be difficult for a start-up business to obtain. Lenders typically want to see two years of profitable business financials,” he added.
Term loans for small businesses typically last three to 10 years. They allow companies to focus on long-term growth by enabling them to afford large investments by paying them off incrementally over time.
“These loans may have competitive interest rates and be more appealing, but it’s often a really time-consuming and invasive process for acquiring capital if you’re working with a traditional bank,” Bumbales said.
“It may not be the best option in some cases because you’re going to be spending so much time jumping through the hoops instead of focusing on your business initiative.”
The U.S. Small Business Administration offers a loan program that encourages lenders to work with small businesses by guaranteeing a portion of their loans, thereby removing some risk. SBA loans give companies that wouldn’t otherwise qualify for a loan the opportunity to access this type of capital.
“SBA loans are a great option for almost every stage of business – start-up, acquisition, recapitalization, expansion …” said Nilssen. “SBA loans require strong personal and business financials, and borrowers typically need 10 to 30 percent liquidity as a down payment, which can be challenging for some.”
Equipment financing involves taking out a loan to specifically purchase hard assets for your business, such as manufacturing machinery or commercial kitchen appliances. Since the equipment itself serves as collateral, this financing method is more accessible and attainable compared with other options for many small businesses just starting out. Bumbales added, “You do need to know that if you default, the equipment is no longer yours. It is a great solution, but some small businesses don’t want to put up any collateral, including equipment. So, they may be better suited to another option.”
Accounts receivable financing
Accounts receivable financing (AR financing) is also known as invoice factoring. It occurs when a small business essentially sells its outstanding invoices to a factoring company at a discount for immediate cash. The factoring company then collects on the invoices. AR financing has a comparably low-risk level for businesses since it involves money the company has already made. “Accounts receivable financing is typically a more expensive financing option, but it can be great for businesses with consistent accounts receivable and a history of profitability with gaps in cash flow that have a difficult time qualifying for a term loan or traditional line of credit options,” Nilssen explained.
Where To find small business funding
There are many different types of lenders that offer funding options for small businesses. The right fit will depend on your business’s needs, your unique preferences, and your current financial situation.
Traditional bank loans have comparably strict conditions and credit history requirements. Therefore, well-established businesses are better suited to working with this type of lender, according to Bumbales. “Traditional banks loans are best for businesses that have been around for a while and are in the black, also for businesses that are looking for mid- to long-term growth. These are not so much for immediate needs or short- to mid-term growth,” he said.
Credit unions are positioned close to traditional banks when it comes to lending, Bumbales said, though with a typically higher interest rate. “If someone is on the bubble between alternative lending and traditional banks, a credit union may make sense,” he said. Nilssen added, “There’s no real difference between how traditional banks and credit unions approach financing.”
While the SBA does not directly loan money to businesses, it offers resources to connect small business owners with lenders who offer SBA-backed loans. “Everybody who can qualify should go after these loans, though they are the hardest to qualify for. They have a more competitive interest rate than traditional bank loans,” said Bumbales. He added that it is important for companies to know specifically how they plan to spend the money before beginning the SBA loan application process.
Compared with traditional banks, alternative online lenders typically have less strict requirements and faster processes, enabling businesses to access cash more quickly. However, alternative lenders usually cannot compete with banks when it comes to interest rate. “Online lenders are a good fit for anyone, especially for a seasonal business or one that has immediate needs,” Bumbales explained.
Crowdfunding is experiencing a heyday, with platforms like Kickstarter, Indiegogo and GoFundMe allowing new businesses to seek funding for projects for a relatively low fee (typically a percentage of the total money raised). Crowdfunding lets small businesses connect with investors without giving up equity or taking on debt.
“What’s nice about it is you get that added brand awareness and you can build a community before your product even launches,” Bumbales said. “It’s a great option for those in a start-up or even pre-start-up phase.”
Nilssen added, “In my experience, crowdfunding is most helpful for product and market validation. If you’re able to secure crowdfunding, you can use that to gauge whether your product or service will be successful in the marketplace.”
Small business grants are cash awards given to companies by an organization for a specific purpose. Unlike loans, they do not need to be repaid. The small business grant applications process can be very competitive and time-consuming, but many companies find it worthwhile for the chance to receive “free money.”
“I think you should always apply for every grant that is available. For specific segments – veterans, for example – there are a lot of grants and start-up competitions that try to be very supportive of the community. I think grants are attainable and whether or not you get them, you’ve put yourself on the radar,” Bumbales said.
No matter which direction your company chooses in 2018, there are plenty of financing options to consider to help you follow through on your New Year’s goals.