Starting a business is exciting but there’s one big question you have to answer right off the bat: How will you fund it? The good news is, there are plenty of business financing avenues to choose from for entrepreneurs who need cash to get operations up and running. Read through this in-depth guide to learn how to finance a new business, then explore your business financing options.
There are multiple ways to finance a business and some might be better suited to your needs than others. Understanding how each one works and what’s good (or bad) about different business financing options can help you narrow it down. Here’s a rundown of eight ways to finance a new business at a glance:
The first option for financing a start-up business is drawing money from your personal savings, otherwise known as bootstrapping. On the pro side, starting a business using cash pulled from your own assets means you’re not going into debt right off the bat. Having to make monthly payments to a lender could be difficult in the beginning if you’re still working on generating positive cash flow.
On the other hand, using your own cash for small business finance is risky for you personally. If the business doesn’t work out, then you’re out the money you invested. Aside from that, your personal savings may only be able to take you so far if you don’t have a lot of assets to draw from. In that case, you might still need to supplement your investment in the business with financing from other sources.
2. Credit cards
Credit cards can offer convenience for businesses that need a way to charge expenses and pay them off later. Not to mention, there are plenty of credit cards for financing businesses that can pay you something back in the form of points, miles or cash back.
If you’re considering a credit card for financing a start-up business, make sure you understand the difference between personal and business cards. While you could use a personal credit card for business expenses, that can get messy when it comes to accounting and filing business taxes. A business credit card could be reserved just for business expenses.
Whether you’re eyeing a personal or business credit card, read the fine print. Specifically, pay attention to:
Regular and introductory APRs for purchases and balance transfers
Card benefits, such as premium travel benefits or shopping protections
Remember, when applying for a business credit card or a personal one, your credit score matters. The better your credit score, the better your odds of getting approved and getting a low interest rate.
One word of caution about using credit cards for financing a new business. Taking a cash advance from a credit card is tempting when you need money fast but the fees and APR you might pay can make it an expensive financing option. So your best bet may be using your card for business purchases only and looking elsewhere when you need cash.
3. Friends and family
Asking friends and family to back your business financially is something you might consider if you don’t have personal savings you can tap into or you’re on the fence about using credit cards for financing.
The upside of asking friends and family to invest in your business is that they may offer you better terms than a lender, assuming they’re lending you money and not gifting it. For example, your parents might loan you $25,000 interest-free. You’d be hard-pressed to find a similar deal from a traditional lender or online lender.
What you have to keep in mind when borrowing from people you know is how likely your business is to take off. If you don’t have the cash flow to repay these kinds of personal loans, that could hurt your relationships. Running the numbers to create some estimated revenue projections can help you gauge your ability to repay what you borrow.
4. SBA Microloan Program
The Small Business Administration sponsors numerous small business financing programs but microloans tend to be better suited for funding a start-up business. The microloan program offers up to $50,000 in working capital that you can use to start or grow your business.
Microloans are a good financing option to consider if you don’t need as much money to get the ball rolling and you don’t want to take longer than six years to pay back what you borrow. Another advantage of using an SBA microloan is that you’re more likely to get competitive rates compared to what you might find when borrowing through traditional financial institutions.
Keeping the interest rate on a business loan as low as possible means less you have to pay back. Plus, you’re not stuck with long-term debt when borrowing through the SBA microloan program.
5. Angel investors
Angel investors and venture capital are two options for how to finance a business that don’t involve borrowing money. Instead, you’re essentially getting funding from individuals or companies that invest in start-ups.
Working with angel investors to finance a business has some key advantages, chiefly that the money you’re getting doesn’t have to be paid back. That means if for some reason your business doesn’t take off, you aren’t left with a mountain of business loan debt to repay. Compared to getting a business loan, which might tap out at $100,000 or $500,000, you may be able to raise millions in funding through angel investors.
There is a trade-off you make, however. When you accept financing from angel investors or venture capital firms it’s typically on the condition that you offer your investors an equity stake in your business. In other words, you’re giving up some of your ownership and control in the business in exchange for an equity investment. That’s something you need to be sure you’re comfortable with before exploring angel investments or venture capital financing.
Crowdfunding is another way to raise money from a group of individuals to fund your business. There are crowdfunding platforms that cater to helping start-ups get off the ground and more general crowdfunding platforms you can use to tap into working capital.
Generally, the premise is the same. You create a proposal on the platform detailing how much money you need and what it will be used for. Investors view your proposal and decide whether or not they want to make an investment in your business.
Some crowdfunding platforms are rewards-based, meaning that instead of paying the money back to investors, you offer them a reward instead. For example, your business might be working on developing a new smartwatch and you could offer a prototype to your biggest backers.
Other crowdfunding platforms are peer-to-peer lenders, meaning working capital is raised from the crowd but it must be repaid to investors like any other loan. When considering crowdfunding as a small business finance option, be sure to read the fine print and compare the fees carefully. Also, study up on what makes for a successful crowdfunding campaign to boost your odds of having your proposal fully funded.
7. Business loans and lines of credit
Business loans and lines of credit are two of the more traditional options for how to finance a new business. The great thing about loans is that there are so many different options. Microloans have been mentioned already but you could also look into:
One thing to keep in mind is that some business loans may be more difficult to qualify for than others, especially if you have a brand-new business. And you may have a harder time getting a term loan from a bank whereas an online lender may be more flexible in offering financing to new businesses.
A business line of credit could be easier to get approved for but it works a little differently than a loan. With a loan, you’re getting a lump sum of money that you can use to fund your business. You then repay the loan according to the repayment schedule set by the lender.
A line of credit, on the other hand, can be a revolving credit limit similar to a credit card. You draw on your credit line as needed to make purchases for the business, then repay those amounts. As you make monthly payments against your balance, you free up available credit that you can use again for future expenses. This could offer more flexibility when financing a start-up, plus you only pay interest on the portion of your credit line you’re using.
Factoring is something you might consider when financing a start-up if you already have some customers and cash flow coming in. With factoring, you’re leveraging your outstanding accounts receivable to borrow money for your business.
A factoring company lends you money, based on the value of your receivables. Depending on how the financing company works, you may repay what you borrow as invoices are paid or the lender may collect payment directly from your customers.
This kind of small business financing option is something to consider if your operating history and credit history don’t allow you to qualify for other types of financing. It’s similar to a merchant cash advance or inventory financing, in the sense that you don’t need perfect financials to qualify and you don’t have to offer collateral the way you might with a traditional loan.
The downside is that factoring can get expensive since lenders may charge fees, rather than a standard annual percentage rate. Depending on the amount you borrow and your repayment terms, the equivalent APR associated with factoring or any other type of cash advance financing could end up being well into the double-digit range.
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