Funding Your Startup: Small Business Loans And Other Ideas
How will I pay for it? That’s pretty much the first question entrepreneurs ask after having a great new business idea. Thankfully, money shouldn’t hold you back from starting your business. With options from traditional funding through small business loans to crowdfunding, there’s a lot of ways to secure cash. This is great news for entrepreneurs who just need a little funding to get their business rolling. Let’s explore the pros and cons of each funding option.
Traditional Funding
Some forms of funding have been around for decades. But while they may have been used for years, that doesn’t mean they’re outdated. Check out the four traditional funding options below.
Bank Loans
Sitting down with a banker may be exactly what you need. Banks are one of the best places to get funding. Most banks will loan to small businesses. They may even have several product lines of small business loans offer. The U.S. Small Business Administration (SBA) also sponsors bank loans. It’s easier for entrepreneurs to get capital this way because the SBA minimizes the bank’s risk.
To get a startup loan from a bank, you should know how much money you need and what you’re going to use it for. The bank will also need some business info from you. Here’s a sample of what they might ask for:
- Business plan
- Licenses and permits
- Evidence of collateral
- Annual revenue, expense and profit reports
- Banking and investment statements
- Accounting documents and balance sheet
- Tax returns (personal and business)
- Lease agreements
- Any legal contracts
Bank loan pros: Bank loans have low, fixed rates, and the loans can be used for many different purposes.
Bank loan cons: You will need collateral to secure a bank loan. Also, banks can have long wait times and lots of paperwork before money hits your account.
Lines of Credit
A line of credit is like a credit card for your small business. Rather than getting money all at once, you gain access to money up to a certain limit. As the money gets used, you pay it back over time with interest.
Many businesses use lines of credit when they need cash fast. If you need money to make payroll, replenish inventory, or secure materials, a line of credit could be the funding for you.
Line of credit requirements are similar to bank loans. Don’t have any valuable assets to put up? Good news—lines of credit are unsecured. That means you don’t need collateral to qualify.
Line of credit pros: Lines of credit give businesses flexibility due to no collateral needed. Plus, a line of credit helps build and strengthen a business credit profile.
Line of credit cons: Just like with credit cards, you should know the interest and fees upfront. They can add up quickly and hurt a business. Sometimes, the limits are too low to be helpful to your business.
Angel Investors
Angel investors are people who have extra cash that they want to make money with. But this investment isn’t all angelic—they give the capital in exchange for equity in a company. Their hope is to get a higher return on their cash than a normal investment opportunity would give them.
You’ll have access to advice and the expertise of your angel investor. If they’ve invested in other startups, you can talk with those companies, too.
Business owners can find angel investors a lot easier nowadays. They could be a mentor who believes in what you’re doing. They may be parents, friends, or loved ones who want to support your company. Other angel investors are serial investors, always hunting for the next big thing. Thankfully, you can even find your angel online.
More experienced angel investors may want formal information similar to banks. Less experienced angel investors may know you well enough to help you out without formal documents.
No matter what they want to see, get a written legal contract before you seal the deal. A legal contract and your business structure ensure the investment follows the U.S. tax code and business laws.
Angel investor pros: There’s less risk when you secure an angel investment. There’s no monthly payment to make, and you may even find yourself with a savvy business advisor—if your angel investor wants to serve as one.
Angel investor cons: The biggest downside to angel investment is the equity stake. You’re giving up a piece of the pie before it’s really grown, which could cost you later on.
Venture Capital
Venture capital is like a super-sized version of angel investment. They make big investments into startup companies with rapid growth, but they do it for high equity stakes. This probably isn’t an option for smaller, lifestyle businesses. Just remember that when you give up equity, you’re giving up some of your control. The investors will usually get a board seat, which means you could have to make a decision that you wouldn’t have made alone.
Venture capital firms are playing their odds like Vegas. They know that only one or two investments will pay off for every 10 that they make. They roll the dice with large investments and high equity so that the ones that boom make up for the ones that bust. One benefit to venture capital firms is you get the expertise of the investors, something that could be invaluable as you continue.
Pros of venture capital: Much like with angel investment, your business gets the capital it needs without immediate risk.
Cons of venture capital: Again, you’re giving away a big chunk of your business from the start. It might be worth it, but you shouldn’t take it lightly!
Non-Traditional Funding
Once upon a time, getting capital for your business meant printing off a business plan and sitting across the desk from a loan officer. There’s now a whole new way to get the money you need. Here’s a look at non-traditional sources of funding:
Online Lenders
Online lenders can do lines of credit and small business loans. But you’re not going to sit down with the banker over a cup of coffee. The process usually starts with an online application. You receive notice of approval or rejection a lot faster than with traditional banks.
Online lenders are less strict with their requirements. They may ask to see tax returns and balance sheets. But, they’ll ask for less than in-person banks.
Online lenders tend to come with higher rates. One online lender may do mostly business lines of credit whereas another may focus on loans to businesses with bad credit history. Take it like a first date—do your research on each lender so you match up with the right one.
Online lender pros: Online lenders deliver fast decisions. They also place fewer requirements on the borrower.
Online lender cons: Online lenders offer higher rates, and borrowers need to do their research. Watch out for predatory lending, which only benefits the lender. Start your search with trusted businesses, like Kabbage.
Crowdfunding
A newer approach is crowdfunding (aka cloudfunding). Rather than getting a large sum from one source (a bank or investor), you get many small investments from average Janes and Joes.
Kickstarter is the best-known crowdfunding platform available. With crowdfunding, figure out the value proposition of your products and/or services. Funders will give money as a donation, in exchange for equity or early release of your product.
Crowdfunding pros: There’s little risk with crowdfunding. Also, a successful crowdfunding campaign generates a lot of publicity.
Crowdfunding cons: Crowdfunding can take a lot of time. There’s a risk of failure, too. If you don’t attract the capital you need, it’s a good sign your products or services need some work.
Self-Funding
You’re the one starting the business, and there aren’t any rules against funding it yourself! Some see this as the riskiest approach to accessing capital. Still, entrepreneurs do it each day. Here’s a look at your options for self-funding your business.
Savings
Are you sitting on a few gold bars? Maybe you’re rolling in the dough? All kidding aside—savings, a Roth IRA, or money invested in stocks could help you fund your business. Sure, there’s higher risk, but there’s also higher reward if the business succeeds.
There are no requirements when you use your savings, and you keep all the equity. That means you make all the rules. Plus, you can kiss those monthly loan or line of credit payments goodbye.
Look, there’s always a chance your business doesn’t take off, which means your savings will be gone. But, you’ll learn from the experience, so it isn’t a total loss.
Savings pros: You keep all your equity, and there’s no repayment to worry about.
Savings cons: You put personal assets at risk. And there’s no guarantee that you’ll see a return on investment. When you pull from a retirement account early, you’ll pay high penalty fees and taxes on the money.
Personal Debt
We get it—debt is a scary word. But, it doesn’t have to be. Taking out personal debt to fund your business is another option. No collateral for a traditional business loan? Can’t secure a business line of credit? Shine up those personal assets because they may help you get funding.
When you choose personal debt, you get to maintain all your equity. But, you will have monthly payments to keep up with. The greatest risk is if the business fails. You won’t be able to pay back the money, which could mean personal credit implications or bankruptcy.
Personal debt pros: Keep all your equity in the business.
Personal debt cons: You take on monthly payments. Also, you run the risk of damaging your credit score and possible bankruptcy if the business fails.
No Funding
It may seem unrealistic, but some startups can get off the ground without any investment at all. This is especially true of companies offering services rather than products.
Bootstrapping
Good news, “bootstrapping” doesn’t mean you have to save your pennies in an old boot. Bootstrapping is used to describe an entrepreneur who launches with little to no money. The owner tries to drive early revenue, and then reinvests it into the business. In time, capital within the business grows, freeing up the owner to operate in a more traditional sense.
While bootstrapping, an entrepreneur may need to limit their personal expenses. In some cases, bootstrapping business owners launch while keeping their day jobs. It gives you transition time until the business develops a monthly cash flow.
Let’s be clear, it’s called bootstrapping for a reason. It’s a tough long-term. But, it’s a great way to launch a business while limiting your risk and keeping all the equity.
Bootstrapping pros: You limit risk and keep full equity in the business.
Bootstrapping cons: It’s a lot of work, and the challenges inherent in bootstrapping can sometimes prevent a business from growing like it should. It can take a lot longer to reach success, which could be your downfall in a competitive industry.
An Aside On Lending Rates
Rates will depend on many factors, including: type of business, length of time in operation, credit history, etc. In general, expect the following rates for different types of capital:
- Bank Loan: Bank loans typically charge interest between 2.5% and 5.5%.
- SBA Loan: The SBA offers various lending programs with interest rates ranging from about 4.5% to 10.25%.
- Line of Credit: Line of credit interest rates typically start at 7% and stretch as high as 25%.
- Alternative Lenders: Loans through alternative lenders typically charge higher interest rates—starting at 13% or more.
How to Choose the Best Option for Your Business
These aren’t one-size-fits-all solutions. But, here’s an example of what businesses may be best with each funding option:
- Traditional Funding: Traditional funding is best for bricks-and-mortar operations that need to invest in equipment or inventory. For example, if you’re opening up a pizza joint, a traditional loan can help you get the industrial kitchen equipment you need.
- Non-Traditional Funding: Non-traditional funding is best for service businesses. Starting an e-commerce website with a remote team? You can use lines of credit to pay employees until your business is profitable.
- Self-Funding: Self-funding is best for individuals who have money they are comfortable putting at risk. Let’s say you’re starting a consulting business. You can launch using your own funds until you secure enough clients to become profitable.
- No Funding: No funding is best for side hustles. Maybe you’re providing freelance or consulting services while maintaining your day job. You may not need funding at all.
Every type of funding has its benefits, and only you know which is best for your business. Maybe you need a small business loan now and a venture capital down the line. There is no one road to success.
Money matters
Learn more about funding your small business and the options available to you from our panel of financial experts in the video below.
The information above is provided for educational and informational purposes only. It is not intended to be a substitute for professional advice and may not be suitable for your circumstances. Unless stated otherwise, references to third-party links, services, or products do not constitute endorsement by Yelp.