Financing a business is a crucial step in establishing and growing a company. Understanding the financing options available can help entrepreneurs make informed decisions.
According to one survey, over half (59 percent) of small businesses reported financial trouble, and nearly 29 percent failed because they ran out of capital. These statistics highlight the need for effective financing strategies.
This guide explores different ways to finance a business. It covers investment arrangements and identifying the best loans to take out. It also discusses the pros and cons of the various funding opportunities and the right time to utilize them.
Investment Arrangements
One primary way to finance a business is through investment arrangements, which can provide substantial capital without immediate repayment obligations. Small businesses comprise 99.9 percent of all U.S. firms and created 63 percent of new jobs between 1995 and 2021. Understanding the different investment types can help companies choose the right partners and structure deals effectively.
Equity Financing
You get capital with equity financing in exchange for giving equity to investors. You don’t need to repay it like a loan, but it dilutes your share in the company. For example, Facebook raised $500,000 from angel investor Peter Thiel in 2004, which helped them expand significantly. In exchange, he got 10 percent equity in the company. The market value of Facebook today is $1.32 trillion, so if he had kept his shares, they would be worth $1.32 Billion.
If you are considering equity financing to fund your business, prepare a compelling pitch deck and business plan to attract investors. They would be most interested in the company’s growth potential and unique value proposition.
Venture Capital
Venture capitalists give funding to startups for a stake in the business. It is similar to equity financing, except that investors often take an active role in the company. You might even consider them partners if they own a large enough share of your company. This type of financing is suitable for companies with high-risk, high-reward profiles because VCs are willing to take the chance for a big payoff.
However, getting venture capital is complex and may not be for everyone’s taste. Over half (54 percent) of small businesses started with personal funds, with another 12 percent relying on friends and family. Only three percent used venture capital.
One example is Airbnb, which received $20,000 from Y Combinator in 2009, which was pivotal for its growth. If you are in the market for a VC boost, build a network of contacts to seek and target venture capital firms that specialize in your industry.
Angel Investors
You might have heard of angel investors, but they are here on earth. Some wealthy individuals act as angel investors; they fund businesses in exchange for ownership equity or convertible debt. They often offer mentorship and networking opportunities. Working with an angel investor is ideal for early-stage firms needing just a bit of funding.
Google benefited from angel investor Andy Bechtolsheim in the early days of its operations. However, angel investors don’t fall from the sky. It would help if you had a robust network to find one who can help you with your business. Participate in pitch competitions and attend startup events to connect with potential angel investors. Be clear about your funding needs and what you offer in return.
Business Loans
Most business owners consider loans a funding source because they are more accessible than finding investors. Additionally, you don’t give up equity or control because you repay any borrowed money with interest over time. However, consider different loan types and providers to find the best fit for your needs.
Bank Loans
Traditional bank loans offer structured repayment terms and typically lower interest rates. However, they require borrowers to have good credit and collateral in the case of secured loans.
A bank loan suits businesses that are established, have solid financials, and might want to expand. Suppose you run a successful bakery and want to buy new equipment to expand your product line. A bank loan would be a good option for you.
Regardless of the profitability of your business, you must maintain good credit scores to qualify for a bank loan. It also helps to prepare detailed financial statements and build a relationship with your local bank.
SBA Loans
The government helps businesses by partially guaranteeing SBA loans, reducing lenders’ risk. They offer favorable terms but involve a lengthy application process.
An SBA loan is an excellent alternative to private loans for small businesses that meet eligibility requirements and need substantial capital. A small retail store securing an SBA 7(a) loan to renovate its storefront and increase inventory would be an example.
Go to the SBA website to see if you qualify for any of the available loan programs. Once you find one that fits your profile, prepare the needed documents to expedite the application.
Online Lenders
Personal loans can help finance a business, especially for small ones and startups. These are unsecured, meaning collateral is not necessary. The loan is primarily based on your credit score and ability to pay. Online lenders provide access to money via a simple application process. However, you will probably pay more in interest than traditional banks.
Working with an online lender is suitable if you need fast, short-term funding for your business. Suppose you are a freelance graphic designer who needs a $10,000 loan to upgrade your software and equipment for a lucrative one-month project worth $20,000. You can get what you need and pay back the loan quickly.
Evaluating Loan Providers
While finding online lenders offering quick loans is easy, you should be careful. Compare various online lenders to find the best interest rates and terms. Check reviews and the lender’s credibility before applying. Read the fine print before you finalize any loan, mainly looking for hidden fees and penalties in the terms and conditions.
Reputable lenders like SoFi offer personal loans at competitive rates and with an easy application process. Here are some of the benefits of using SoFi for your personal loan needs:
- Low fixed rates: SoFi offers competitive fixed interest rates on personal loans. That means you’ll know your monthly payment for the life of the loan, making it easier to budget.
- No fees: SoFi does not charge typical lender fees like prepayment penalties, late fees, or origination fees, saving you a significant amount of money.
- Same-day funding: In some cases, SoFi can fund your loan on the same day you apply. That is an excellent option if you need money quickly for an unexpected expense.
- Large loan amounts: SoFi personal loans range from $5,000 to $100,000. That means you can borrow enough to cover many things, such as debt consolidation, home improvement, or a major purchase.
SoFi personal loans and similar are excellent for borrowers looking for competitive rates, no fees, and fast funding. However, it pays to compare shops.
Interest Rates
Check the interest rates of various lenders. Competitive interest rates reduce the overall cost of the loan, improving cash flow and reducing financial strain.
A small business loan typically has an interest rate of 2.54 to 7.01 percent, so that’s a good benchmark for deciding on a provider. You can also negotiate with lenders to secure the best possible rate. Highlight your business’s financial stability and growth potential to strengthen your bargaining position.
Ease of Application
Anyone who has tried to get a traditional bank loan understands how long the application process can take. Fortunately, many lenders today offer streamlined applications that save time and effort.
Online lenders like SoFi offer user-friendly platforms, which can help ease the stress for small business owners juggling multiple responsibilities. However, you should also do your part. Gather your financial and other documents before applying. Ensure your business plan and financial projections are clear and detailed.
Money Begets Money
No business, regardless of its potential, can run without money; getting enough can be a struggle for many small businesses. Fortunately, you have options and should explore them to ensure they are the right fit for your circumstances. Seek expert advice when necessary to ensure long-term business success.
