Choosing how to fund your business is one of the most important decisions you’ll make when starting a new company. When you’re first starting out, you have plenty of funding options. Take the time to find the right one for your needs. Remember that funding isn’t one-size-fits-all, so what works for another company might not be the best option for you.
Determining your business funding needs
Before you fund your new company, you need to determine how much money you need. Your business funding needs may include:
- Money to buy supplies and equipment
- The cost of any starting inventory or raw materials you need
- Rent for your physical store or office
- Overhead for daily operation, such as water and electricity costs
- Payments for any necessary government permits or licenses
- Legal and professional fees to incorporate and register your business
- Money to pay employees and managers
- Marketing costs
- Funds to support your business activities
If you’re looking for a loan or other outside funding, you need to be able to justify the amount you’re requesting. You must supply written documents stating exactly how you plan to use the cash once you get it. You’ll also need to disclose any other funding sources. You shouldn’t approach a lender asking for whatever amount they’ll give you. Asking for a specific amount is more likely to get a positive response.
Be careful not to underestimate your funding needs. You should have enough working capital to support your business for a few years. Working capital includes the money you pay employees, ongoing expenses, and supplies. If you don’t include these on your funding application, your lender may not trust you to manage a loan.
Funding your company with self-funding
Many startups use self-funding when they first get started. Self-funding involves using your own money to start your company. You might have cash on hand or money in a savings account that could finance your initial business expenses. You could use your home or other assets as collateral for a loan.
Some new business owners put startup expenses on a credit card or take out a new line of personal credit specifically for this purpose. You might also be able to take money out of your IRA to fund your business. Talk with an accountant before deciding how to self-fund your business since there may be specific federal or state rules that apply.
Self-funding isn’t always just about providing money out of your own pocket. It also includes money loaned or given to you by family and friends. If you go this route, present your lenders with a business plan before they invest. Anyone investing in your company should understand what they’re funding.
It may be easier to ask multiple people for small amounts instead of relying on one person to fund everything. Each person in the transaction should sign a contract. A good contract spelling out how you plan to use the money and any repayment terms lets everyone know what to expect.
Keep in mind that you aren’t stuck with self-funding forever even if you start that way. You can always switch to other forms of funding once your business gets big enough to attract investors or qualify for a bank loan. Many outside funding sources will require that you self-fund at least part of your startup costs.
Small business financing with venture capital
Venture capital offers a quick infusion of cash into your new company right when you need it. A venture capitalist is an individual investor who provides money to a company in exchange for an ownership stake in that business. In practical terms, this means that the investor becomes a co-owner of the business and often takes a position on your board of directors.
Most venture capital involves large sums of money, so these investors work with high-growth companies such as tech companies. Venture capitalists also want a return on their investment. This might mean that they expect profits within a few years. Because venture capitalists are co-owners, they could force you to sell your company to get back their money.
Finding an angel investor
Another type of investor similar to venture capitalists is the angel investor. Like venture capitalists, angel investors provide money in exchange for part ownership of your business. The main difference is that angel investors provide smaller amounts than venture capitalists do. Angel investors typically offer $25,000 to $100,000 in startup funding, while venture capitalists often provide sums in the millions.
Finding an angel investor often involves networking. A local small business development center or chamber of commerce may be able to connect you with angel investors. If you attended college, your alumni association may be another place to seek out investors to fund your business.
To attract an angel investor, you need to have a solid business plan, and be able to communicate your vision in a unique and memorable way. Being in an exciting industry helps because angel investors tend to prefer unique, cutting-edge, and innovative companies to invest in. You may have to make a pitch to the investor to get funding.
Using crowdfunding for small business financing
If you have a big social media following or an innovative idea that intrigues people, consider crowdfunding to fund your business. Crowdfunding involves raising money from a large group of people. You set a specific monetary goal and how long the crowdfunding period will last. Each person gives a small amount until you reach your funding goal. If you don’t reach the goal before the time period ends, the money is returned to your backers.
People who participate in a crowdfunding campaign don’t get ownership in your company or money paid directly back to them. Instead, companies who crowdfund offer rewards to backers, such as early access to the product or special, limited-edition versions.
How to get a small business loan
A small business loan works just like any other loan. The bank lends you a specific amount of money to fund your business. Then you must make monthly payments until it’s completely paid off. The lending institution also charges interest on the loan, which is included in your monthly payments.
For new business owners wondering how to get a startup business loan, the first step is to contact a bank or credit union. Small business start-up loans don’t usually cover all of your expenses. Banks often want to see that you’ve put some of your own money into the business before they offer you a loan. Small business loans are often easier to get once you’re already established.
Choosing a lender
When you’re searching for a small business loan to fund your business, you need to find a lender who works with companies like yours. Some banks may prefer to work with larger corporations. Some lenders specialize in a specific industry.
Compare a few loans before choosing which lender to use. Some questions to ask when approaching a lender include:
- Do you work with small businesses and startups?
- What’s the payment schedule for this loan?
- How many months or years does this loan take to pay off?
- What’s the interest rate for this loan?
- How long is the loan application process?
- When is the first payment due on this loan?
- How do I make payments on the loan?
Remember that shorter-term loans usually have higher monthly payments but lower overall costs. Loans with longer terms accrue more interest, so they cost more over time. This can happen even if a longer-term loan has a lower interest rate.
SBA loans to fund your small business
The US Small Business Administration (SBA), offers a few loan programs through banks. You have to meet the qualifications and be turned down for a conventional business loan before being considered. The main SBA loans used by small businesses are:
7(a) loans
SBA 7(a) loans require a credit check, so make sure your credit is up to par before applying. These loans are usually given to already-established businesses, franchisees, and professionals such as veterinarians or dentists who are starting their own practice.
Microloans
Microloans backed by the SBA are small loans under $50,000 intended for use purchasing equipment and supplies or as working capital. Nonprofit organizations may also offer microloans that aren’t backed by the SBA. Microloans generally have higher interest rates than regular bank loans.
504 loans
504 loans are specifically designed for equipment funding. The equipment you purchase with the loan money is used as collateral for the loan. This means that if you don’t pay back the loan, the lender can take that equipment and sell it to get that money back.
Applying for any small business loan can be a long and complicated process. Being prepared helps everything go more smoothly. Some things you may need to bring when you apply for a small business loan are:
- A detailed business plan
- Financial projections for the next five years
- An expense sheet
- A marketing and sales plan
- Tax returns and financial data for your company and yourself as the owner
Funding your startup with a business credit line
If you can’t secure a small business loan, you might be able to get a business credit line or credit card. Both are revolving lines of credit that you pay back in monthly installments. You don’t start paying until you use the credit line to borrow money.
You can use a business credit card just like a personal credit card whenever you check out at a retail business or online. The limits on this type of card are fairly low. Business credit cards are best used for smaller purchases.
A business credit line typically has a lower interest rate and larger credit limit than a card. You can use a business credit line to cover employee paychecks, large equipment purchases, and other big expenses.
The activity on a business credit line or card is reported to credit bureaus. Missed or late payments can affect your credit score. If you have trouble getting a business credit line as a startup, you may want to try again. It’s usually easier to get one after you’ve been in business for six months or more.
Preparing for your loan search
Whether you’re looking for a short-term loan or an ongoing line of revolving credit for your company, your personal credit history affects the results. If you have poor credit, work on improving your credit score before you apply for business credit.
Once your business is up and running, monitor your business credit profile. Building up a good credit score for your company can give you access to larger loans and bigger lines of credit later. Keep accurate records of all business activities for future funding applications.