Financing Your Business

One of the most challenging decisions you have to make for your business—and one you’ll have to make again and again—is how to fund it while it grows. Every business has expenses for equipment, inventory, staff, product development, technology, and real estate, yet few can completely finance their own needs.

The good news is there are many options—either debt financing (loans for you to pay your expenses), equity (selling a piece of your business in exchange for funds), or some combination of the two. The not-so-good news is the terrain can be complex and risky. Here we’ll cover the range of options and discuss the pros and cons of each.

Savings

Generally, the safest way to fund your business is to set money aside for that purpose, then pull from savings. For existing businesses, keep a tight rein on spending so that you can save up for the larger funds you will later need to spend outright or use as collateral for a loan.

Pro: Safe, ease of access, no fees or interest incurred, does not affect business ownership
Con: Funds may not be available. IMPORTANT: Pulling from personal retirement funds or a loan against your home is very risky and not advisable.

Credit Cards

When managed well, using credit cards can be an immediate source of funding, help build up your credit score, and extend your cash flow. However, if you are unable to pay in full each month, the interest you pay will quickly add up, making this an extremely expensive way to fund your business. Use this method judiciously.

Be sure to shop for the right card for you. Look for the lowest rates and little to no annual account fees. If you expect to pay your bill in full each month, the rate will be less important to you, whereas reward programs and protections may be very useful. You can earn flight miles, cash back, gift cards, and more.

Pro: Ease of access, flexibility, reward programs, does not affect business ownership
Con: High rates, cash advances trigger high fees

Your Personal Network

Giving those you know an opportunity to invest in your company can be a great way to fund your business. You might offer family or friends an equity stake or set up their investment as a business loan. Either way, be selective and thoughtful about who you ask and explicitly define terms. If the business goes under or you can’t pay back the loan on time, your relationship with that person may be damaged permanently. Also, know that any investor you bring in will likely become very involved in your business, something you may or may not want. No matter which avenue you go, discuss expectations including the upside and downside, and above all, get it in writing. Hire an attorney to draft the terms and be sure all parties sign it before proceeding.

Pro: Ease of access, negotiated terms may be better than other options, often does not affect business ownership
Con: Negotiated terms may not be better (loss of control, potentially higher rates), investors may become too hands-on, risky personally and professionally if you cannot honor the terms or do not agree on business decisions

Commercial Loans

Business term loans (specific $ amount of funding with set periods of repayment and interest) and lines of credit (funds available to use as you need it up to a set amount) are great financing tools that banks and credit unions make available to established businesses. Lines of credit are particularly helpful sources during times when cash flow is soft, due to seasonality or slow-paying clients.

Because you must have considerable assets and healthy cash flow to qualify, banks are not a great source for unstable businesses or start-ups, unless connected with a proven commodity. They are looking to fund solid and growing businesses. The application process can be cumbersome, requiring a detailed business plan, financial and cash flow statements, and other documentation.

Pro: Low rates, retain complete control and ownership, great options for more mature small to large businesses with a solid credit history, cash flow, and assets, various types to suit different business needs. For lines of credit—only pay interest on the funds you use
Con: Harder to qualify, may be a lengthy approval time, must have strong cash flow and/or collateral to back the loan

SBA Loans

While the SBA (Small Business Association) doesn’t directly issue loans, they can help you get business loans. The SBA agrees to act as a partial loan guarantor so that their financial partners (banks, credit unions) will give you a loan with really good terms, one you wouldn’t likely be able to get from those sources on your own. Unfortunately, 90% of SBA loan applications are considered to be too risky and are rejected.

Do your homework to see what type SBA fits your company and need. There are general purpose loans and larger loans for equipment and real estate. There are also loans for special situations fitting certain applicants, such as veterans and members of the military applying for a business loan or a need benefitting a rural community. Once you know where you fit, then talk to the SBA.

Pro: Lowest rates, best repayment terms, low down payments, for large or small loans, free management advice, usually better terms than you would get from a commercial bank without SBA help, does not affect business ownership
Con: 2-3 month approval time, extensive paperwork and vetting, may require collateral, personal guarantees are required—in the event you default you are personally liable, not an option for those without good credit scores

Crowdfunding

Crowdfunding sites are online platforms providing businesses a viable and low-risk way to raise funds from a potentially large group of people—with the operative word being potentially.

For businesses planning to launch a new product with the potential for strong public appeal, reward-based crowdfunding sites like Kickstarter have successfully raised thousands or even millions of dollars in exchange for giving investors pre-sale versions of the product, discounts, or perks. Products that are creative, unique, and are novel and intriguing tend toward greater success with this form of financing. Tech gadgets and creative projects rule here—matter of fact, these are the only pitches that Kickstarter allows. Kickstarter is an all or nothing game. While it’s great when it works, the majority of campaigns do not hit their goals, meaning $0 in funding.

Then, there’s equity crowdfunding. Partially due to the fact that there are only half as many publicly traded companies to invest in than there were a few decades ago, equity crowdfunding sites have become viable investing and financing options (depending on the side of the fence you’re on). These private equity sites are for businesses willing to offer small stakes in their business to a large number of investors for as little as $500. If your venture is not successful, you owe investors nothing. If it is, the investors reap a share of the profits. You control how much you want to raise (it’s not all or nothing as in some reward-based platforms), what you want to sell, for how much, and all terms. Because the investor’s goal is to make a profit, each one becomes a brand evangelist for your business, inching you closer to success.

The downside of equity crowdfunding, especially at larger funding levels, is the number of hoops you must jump through. It is a highly regulated industry. The SEC regulates the maximum you can raise, currently at $1.07 million without an audit. Companies interested in raising up to $50 million are considered mini-IPOs. Here a securities attorney, a two-year audit, and much more complex preparation is required.

When considering crowdfunding platforms, compare the fees and policies, how your proposal will get noticed, and the amount of time it will take you to apply and develop presentation materials to be on their site.

Pro: Rewards-based crowdfunding platforms offer easy access, low risk, fast, potential to raise small to large sums, most do not affect business ownership. With equity platforms you control how much overall stake you’re willing to part with. Other benefits for equity platforms: no collateral needed, owner sets terms, SEC allows up to $1.07 million or up to $50 million that can be raised annually, each level with differing requirements.
Con: Less than 30% of reward-based campaigns result in any funding; the likelihood of large dollar funding is minimal. For equity platforms: Greater chance of business failure than with VC firms because no VC steering is provided, heavily regulated with cumbersome rules, there are no quick launches, you may not qualify and extensive preparation is required if you do. Applications to raise over $1.07 million take 3-5 months or longer to be processed. Investors do not necessarily have expertise in your business.

Angel Investors

Though family and friends are technically a type of angel investor, true angel investors are affluent individuals—or groups of the same—who actively seek businesses to invest in, usually in a startup or expansion phase. They are private funders generally with $100,000, $500,000 or more to invest that are looking to become 20-50% owners of select businesses in exchange for their investment. You can often locate these individuals through local business associations, chambers of commerce, or social networks such as LinkedIn. However, you find them, you’ll need a strong pitch deck and business plan.

Pro: Large funds possible depending on the angel, strong cash flow and collateral are not required, funds generally do not have to be paid back, may provide business expertise the owner lacks
Con: Giving up a sizeable portion of ownership, portion of profits go to the angel investor, may experience potential conflicts in vision

Venture Capitalists (VC)

These are companies similar to angel investors except that they are professionally managed firms using pooled investment funds instead of one individual using their own. VC firms offer more money than most angel investors in exchange for controlling interest in the business. VC firms are usually interested in highly profitable industry sectors such as IT and pharmaceuticals with an eye toward taking the company public to reap big returns. As with angel investors, you’ll need a strong pitch deck and business plan.

Pro: Large dollar investment, funds do not have to be paid back, provides business expertise the owner may lack
Con: Hard to qualify, VC takes majority ownership and may take control in steering the business

How to Proceed

No matter which sources you decide to use to finance your business, here’s a few tips:

Watch out for fees, interest rate, repayment terms & deadlines, or forfeiture conditions for any lending options you are considering.
Calculate the monetary value of the interest to be paid over the life of the loan, so that you can judge in real dollars and cents whether taking out the loan is worth it.
Know your credit score. Get your credit report for free from the three credit-reporting companies—Experian, Equifax, and TransUnion. If your score is in the 700s or 800s, you’re on your way. If there are mistakes in your credit report, take steps to correct them and show your potential funder all related correspondence.
Work with a business consultant to help you prepare your business plan and overall loan package. SCORE’s volunteer counselors, both working and retired business execs, will assist you for free.
For equity arrangements, take your time to fully discuss what the investor expects from you and the business and how they wish to be involved.
Be ready to pitch your “5 C’s of credit” as evidence that you are a good credit risk:
- Character—as reflected by your credit history
- Capacity—your debt-to-income ratio calculated by dividing your total monthly debt by your total monthly income. This indicates your ability to pay back the loan.
- Capital—money and other assets you have on hand to put down, usually as a percentage of the loan
- Collateral—assets to back the loan should you be unable to pay
- Conditions—reason for the loan, how much you need, and the condition of your business. The lender will also consider factors outside your control such as current interest rates, industry outlook, economic outlook, and even the state of their own loan portfolio.

Plan ahead and build a strong and thorough case, and you’ll find the financing source that best suits your needs.

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