When you're starting your business, you might need funds to purchase equipment, obtain a storefront or build up your inventory. Even after you've been established, you'll likely need financing to expand operations, hire additional staff or cover emergencies. Four sources of finance you might consider for your small business include personal savings, loans, grants and investors. Other options may include gifts from family, credit cards, stock sales and crowdfunding.
Whether you're seeking sources of finance for a partnership or a single-person business, understanding the pros and cons of these options as well as their intended uses will help you make the best financial decision.
Sources of Finance: Personal Savings
One of the common sources of finance is personal savings. If you've been saving money for your small business or have some money in an old 401(k), you may contribute that cash to your startup costs, but you may still need to seek additional financing options. For example, an internet-only business might require expenses for only a laptop and website, but you may find it much more difficult to have enough cash to start a local bakery.
When using personal funds as a source of finance, be aware of the risk of not leaving enough cash aside for emergencies. It's also important to avoid wiping out your entire savings to start your business. If you also take money from a 401(k), consult with a financial professional to learn about the impacts on your taxes and future retirement.
Asking Your Family and Friends
Friends, family members and acquaintances in your neighborhood are all potential sources of business funds. If they support your business idea, they may give you cash toward your startup costs as a gift, or they might offer a private loan.
Gifted funds help save you interest charges and are especially appealing if you can finance the rest of your business using cash. If you do opt for a loan from a personal contact, though, it's recommended to write up a contract with a payback term and any interest rate desired to avoid later disagreements.
Taking Out Loans
Business loans and personal loans are both sources of finance for new businesses. These are widely available through traditional banks as well as online lenders.
If you're needing to borrow a large amount of cash, a business loan can be ideal as long as you can meet the strict application requirements and find a lender willing to work with you. Depending on the lender, you may need to show your business plan, proof of a specific amount of revenue, a business license and information about your other debts and assets. This means it can be harder for a startup to obtain a business loan than for a small business that's been operating for a few years already.
Personal loans are an alternative that tend to offer lower limits than business loans. However, they tend to be easier to qualify for than a business loan and also allow you to get your funds faster. If you choose this business financing option, do be warned that your interest rate may be high and your personal credit is at stake if you default on the loan.
Seeking Funds Through Venture Capitalists
If you have a business idea in a hot industry like technology and expect to be very profitable, you may get attention from venture capital firms. Although harder to get, especially for small businesses, this form of financing can provide you with a very large amount of money in the hundreds of thousands or even millions of dollars.
Seeking to profit from your business growth, venture capitalists provide equity financing for businesses, meaning they offer you money in exchange for a share of ownership in your business. For example, they may receive stock from your company or otherwise be paid an agreed-upon part of your profits. In addition, they gain some control over how you run your business for a period of time. After the investors have received their return – perhaps three to five years later – you can get back full ownership.
You can research venture capital firms online to learn about their application processes and the types of companies they have worked with. You can expect to submit a detailed proposal explaining your business idea, needs and intended results as well as undergo a thorough evaluation from the venture capital firm. Consider choosing a few firms to which you'd like to apply and introduce yourself in person if possible rather than using email.
Finding Angel Investors
Angel investors are similar to venture capitalists in that they offer financial support in exchange for some ownership in your company. However, they are different in that their reason for investment isn't primarily focused on the profits they might receive. Rather, they may want to help a startup get built for reasons such as being interested in the product or service, the individuals managing the company or the potential of economic growth in the community.
While venture capitalists are often part of a firm, angel investors tend to be private individuals with significant income and a high net worth. You might find such individuals willing to invest in your business in your community, online or at local business organizations.
In addition to visiting business meetups in your community, check out websites like Gust, the BC Angel Forum and the Angel Capital Association to find potential investors. You might even find that you already have some acquaintances willing to serve as angel investors, so it pays to share your business idea.
Looking Into Business Incubators
With more people wanting to start their own businesses, small business incubators have become more popular. These organizations provide support in the form of coaching, expert knowledge, networking and free or cheap office space. They commonly offer training programs for entrepreneurs as well.
Many business incubators also offer financing in the forms of loans, investors and grants, although amounts and conditions vary widely. For example, one incubator might give you a $1,000 grant if you finish a business course, while another might give a short-term loan for a few months to pay for your startup expenses. You may also get to share your business idea with investors who may help finance you in exchange for a portion of your equity.
Applying for Small Business Grants
The Small Business Administration offers numerous grant programs that can provide years of financial and professional support to your business. Some options are targeted toward women, veterans or entrepreneurs in a specific location or industry, while others are general business-funding opportunities.
You can apply on the SBA's website and also read the conditions for each grant. Typically, you'll be expected to meet the SBA's performance guidelines and use funds for approved activities.
You can also find grant programs through governmental organizations, nonprofits, professional organizations and business centers. Checking your state's department of development can show you potential government grants in your location. When comparing your options, know that some grants are one-time only, while others offer monthly or quarterly business funds.
Using Credit Lines and Cards
If you need to borrow money to pay for ongoing expenses, then consider using business credit cards or lines of credit. Both options give you some credit readily available for emergencies or large purchases.
One of the benefits of business credit cards is that they often come with potential rewards for purchases like cash back or airline miles. Furthermore, qualifying is possible even if you've not yet generated business income. The bank will simply use your personal income and credit score. However, be aware that this type of credit tends to have high interest rates and annual fees and that a business credit card isn't typically intended to fully pay your startup costs.
A business line of credit is an alternative to a business credit card that can come with a higher credit limit, but it can be much more difficult for a new small business. Not only do lenders look for two years of successful operations, but they also demand collateral and solid financial ratios and require you to follow a covenant of rules. Therefore, you might consider a business line of credit after you've achieved a good cash flow for a few years.
Taking Advantage of Crowdfunding
With the rising popularity of sites like Kickstarter and Indiegogo, it's become easy to share your business idea and get funds from people around the world. These sites allow you to set an amount of money you need to obtain and share updates and videos about yourself and your business. In exchange for donations, you might offer your donors rewards like discounts on future service, an early product release or recognition.
When the campaign ends, you can easily transfer the money to a bank account or PayPal account. When using crowdfunding, though, be aware that the site will take a small piece of your funds, often between 5 and 10 percent. You'll also want to check your chosen site's payment terms since some will return all funds to the donors unless you reach or exceed a set goal.
Selling Your Company Stock Privately
As a small business, you likely can't make your stock available to sell to the public, but offering stock privately is possible. By offering private stock, you give up some ownership to your shareholders, but you also gain some cash that you can use to buy equipment, pay debts or otherwise finance operations.
This option is more common for established small businesses that have demonstrated the financial success that encourages shareholders to invest. However, that doesn't mean a brand-new company can't find investors to purchase stock, such as personal contacts, employees, angel investors and venture capitalists.
The process for being allowed to issue private stock will depend on state and federal laws. While you probably won't have to deal with the Securities and Exchange Commission like larger public companies, you will probably have to make a private securities filing with your state, provide a disclosure document and come up with an agreement for stock sales.
Considering Leasing as an Alternative
If you need funds to purchase a piece of equipment or a building, an alternative to seeking financing for the purchase is to consider leasing. Not only will this allow you to get what your business needs without tying up a lot of money, but you can often find flexible payment options. Also, this can be a good solution if you only need short-term usage of the item.
While some lease agreements might require a large lump-sum payment each year, others allow more affordable monthly payments. You can choose to renew the lease when the term expires, or you can simply return the equipment or vacate the building per the lease agreement. In some cases, you may even be able to purchase what you leased, which can be helpful if your financial situation has changed.
- BDC: 7 Sources of Start-Up Financing
- Iowa State University Extension and Outreach: Types and Sources of Financing for Start-up Businesses
- Lend Academy: 6 Small Business Loan Options & Their Pros and Cons
- Forbes: Debt vs. Equity Financing: Pros And Cons For Entrepreneurs
- Merchant Maverick: 8 Ways to Finance Your Small Business
- Student Loan Hero: 6 Things to Keep in Mind Before Using a Personal Loan for Your Startup
- Commercial Capital LLC: Business Line of Credit Requirements
- Mercy Corps Northwest: Incubator Microloan
- Bplans: 10 Tips for Finding Venture Funding
- Investopedia: How to Sell Stock in Your Company