UPDATED: March 23, 2022
Small businesses start with a dream. But when that dream turns into a workable plan, and you get your business off the ground, the sheer cost of continuing to run it can be staggering. The good news is there are plenty of options available to fund a small business. Here’s what you need to know.
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What’s the Best Way to Fund a Small Business?
There are several options for funding a small business. Which you choose is going to depend on the type of money you’re looking for. While ideally business owners would have interest-free money dropped into their laps, the reality is there are two main ways to secure funding:
- Sell Equity
- Take on Debt
Equity investments are made by individuals who want to give money in exchange for a piece of your company. That means these investors aren’t seeking to be repaid in interest but in dividends when your business starts earning money. A common type of equity investment is venture capital.
A debt investment is in the form of a loan or bond. The issuer extends a set amount of money in return for an agreed-upon interest rate. You’ll be required to pay back the amount borrowed based on clearly defined loan terms. But the big upside of debt investment, like a loan from a bank or credit union, is that you’ll be able to keep 100% of the equity in your company. Another form of debt is a small business credit card.
How Do I Know If My Small Business is Ready for Funding?
If your business is inundated with customer demand, you may need to expand just to keep up. But before you seek out funding sources, ask yourself the following questions.
- How much money do I need? Given the high failure rate of small businesses, it’s best to take out money sparingly and only for the amount you absolutely need to keep the business moving forward. You’ll also want to be sure to develop a financial plan that clearly details how the investment money will be spent.
- Am I willing to give away a part of the business to secure funding? For small business owners, giving away some of the company might feel like giving away your own flesh and blood. So if you’re unwilling to part with an equity stake in the company, you may want to seek out debt funding instead.
- Do I have a track record of responsible money management? Anyone who invests in your business will want to see what you’ve done with money so far. Since most small businesses are bootstrapped using very little capital, it’s wise to keep detailed records of where you’ve spent money previously to prove that you’re worthy of managing it in the future.
Requirements to Secure Small Business Funding
Specific requirements may vary based on the type of funding you’re looking to secure. But there are some overarching documents you’ll want to keep nearby if you’re ready to find funding.
- Your business plan: A well-written business plan lets investors know that you have a clear picture of how you fit in the existing market. It also shows that you’ve put in the leg work and will likely continue to do so after getting funding.
- References: Lenders may want to hear from individuals who can vouch for your responsibility before they fork over a significant investment.
- Details about your product or service: Investors will likely want to know about the various ways you intend to make money by selling your products or services.
- Your existing investment: When you have more money in your business, it might convince future investors that you’re more likely to see it through or to pay back a loan.
- Your existing debt: Lenders will want to see how much debt you’ve already taken on if any.
- Personal credit score: Especially for young businesses without much of a financial track record, financial backers may want to see your personal credit score to gauge your worthiness as a borrower.
Ways to Fund a Small Business
If you’re ready to move forward with funding your small business, several options are available.
Many banks have flexible funding options and offer term loans (secured and unsecured), lines of credit, and SBA loans. An SBA loan is issued by a bank but with government backing. Check the SBA website to see if you’re eligible and to apply for a loan.
Banks will assess applicants on key areas like:
- Personal credit score
- Years in business
Funding from a bank is best suited for those businesses that have been around for two or more years. If that’s you and you have good credit and a non-urgent need for cash, a bank loan could be just what you’re looking for. Consult your local bank to determine loan eligibility.
Credit unions are not-for-profit member-owned organizations. That means they seek to serve members over making a profit. Becoming a member of a credit union may result in more favorable rates and lower fees.
Typically, the criteria to get a small business loan from a credit union are closely aligned with those of a bank. Credit unions want to see established businesses that are profitable with good credit before they’ll extend a loan.
Equity investors like venture capital (VC) firms typically look for small businesses doing something new and different in their respective industries. VCs invest in companies with high growth potential. In exchange, they capture equity which they hope will return many times over when the company eventually goes public or sells on the private market.
The primary benefit of working with a VC firm is that small businesses can leverage the expertise of the key players within the firm and their network. But be sure your business plan is airtight before you seek VC funding. Even still, you’ll probably hear many “no’s” along the way. If you do receive funding, it can put an added level of scrutiny on all of your business activity, which can end up becoming quite stressful.
If you have an idea that appeals to the general public, crowdfunding could be a viable option. The idea of crowdfunding is that you’ll gather small investments from many investors and provide some sort of incentive or repay the loan in return. Popular crowdfunding platforms include Kickstarter, Kiva, and Patreon.
For example, let’s say your company is in the business of offering fitness classes. You might set up a crowdfunding investment to purchase workout equipment. And in exchange for a $100 investment, you could offer a 3 class pass. That way, you get the capital to fund your business needs, your investors get an incentive to help out, and best of all, there’s no loan to pay back when all is said and done.
If you’re looking to use a crowdfunding platform to get a loan, you can always ask for investments with a promise to repay the investor’s loan by a set date. By setting clear expectations up front, you may only be required to pay minimal (or no) interest to the individuals who provide your short-term loan.
The Bottom Line
Building a business is an exciting time. But it’s also a costly one. If you need funding to keep your business moving forward, there are options. Consider whether you want to provide equity or take on debt. Then review options and apply for the funding that best suits your company’s needs and keeps you moving forward.