Understanding the Basics of Small Business Financing
Evaluate Your Small Business Financing Options With These Five Options
Getting started down the road of owning your small business takes a little risk and a lot of passion. Unfortunately, lenders don’t consider willingness to take a risk and passion as criteria for financing. Small business financing is the traditional pathway for companies to get started or even keep the lights on until profits start rolling in. Even well-established businesses will find themselves in need of working capital to scale their business upward.
Knowing your options is the best place to start when considering small business financing. As with many endeavors, there is a mass of ground to cover before signing the paperwork. Depending on your situation, the nature of your business, and how much money you need, will affect which financing route you’ll want to choose. Only 20% of small business owners actually qualify for a bank loan. Bank loans generally have the best interests rates and terms but are not always a viable option.
This article will break down the alternatives. Here are the top five easiest and strategic small business financing options.
1. Invoice Financing & Online Vending
For small business owners whose cash flow is contingent on customers paying their outstanding invoices should consider invoice financing. This is also a good option for business owners with uncertain credit. Essentially, these outstanding invoices are used as collateral to a lending service provider. Once your customer’s bills are settled you can pay back the lender.
Receiving a short term loan is a debt financing option for those in need of a quick cash supply. Term parameters are between 3 and 18 months with interests rates around 14%. Many choose this route because applying is quick and funds could be issued within days. In 2015, the U.S. Treasury expected that more than 70% of small business would take advantage of online vending.
Many online lenders supply both short term loans and invoice financing. Applying is simple, funds disburse quickly, and data can be integrated into your company’s accounting software.
2. SBA Loans & Grants
The small business administration is a segment of the government in place to assist small businesses to get loans they typically wouldn’t qualify for. The way it works is the SBA incentivizes lenders to loan money to small businesses. The SBA will guarantee the majority of the loan based on their standards. If a business defaults, the lender doesn’t lose as much. This makes it less risky for lenders. Interest rates are usually between 6 and 13% with terms up to 25 years. The most popular loan program is the 7(a) loan.
The SBA also offers grants to businesses with scientific and research focuses. Federal grant eligibility must meet federal research-and-development goals with potential for commercialization. Branches of the SBA are in place to stimulate economic growth in these areas.
3. Angel Investors & Venture Capitalists
Startups in the process of transitioning ideas to a business plan can utilize small business financing through an angel investor. This process involves pitching your business plan to a potential investor. If the investors are agreeable they will front you the money for ownership equity or convertible debt. Angel investors are often affluent and wealthy individuals willing to risk their own money to launch early-stage businesses.
Venture capital is a similar form of small business financing. An angel investor uses their own money for investment whereas venture capitalists work for firms. This means that venture capitalists can supply larger investment amounts but the capacity of risk will be scrutinized more comprehensively.
4. Business Credit Cards & Lines of Credit
A business credit card is helpful for immediate small purchases. Qualifying is less scrutinizing, special deals on 0% introductory APRs are typical, and high credit limits are enticing reasons to use a business credit card as a method of small business financing. Purchases can automate into accounting software. This makes it easy to separate personal finances from your small business. Credit cards also have bonus rewards and cash back savings. These will add up.
Of course, there are drawbacks. Relying too heavily on credit cards can provoke late payments and overdraft penalties. This will hinder your credit score ever further. Interests rates are around 10 to 22% so if you qualify for a better rate on a loan you might consider this route to finance the bulk of your small business.
Lines of credit work similarly to credit cards. Small business owners are allocated a pool of funds that can be withdrawn from when needed in a revolving line of credit. Interest is only paid on money that is used. Once the lender is paid back, the pool is filled to the original amount. Small business owners with strong credit scores, proven business longevity, and high annual revenue qualify for this opportunity in small business financing.
5. Merchant Cash Advances and 401(k) Loans
A merchant cash advance is a quick but expensive solution in the long-term. Small business owners are advanced a lump sum loan. This is paid back through a percentage of daily credit card sales. Many go this route because there is no penalty when you have slow weeks in profit. Seasonal business can use this when profits are marginal. There is also less paperwork and you can receive funding in a few days. The difficulty with merchant cash advances is that high rates can impact your profits. APRs can be anywhere from 15 to 80%. Consider this option for the short term.
For small business owners ready for the next challenge, using tax-deferred retirement savings as seed money can get things moving. Setting this up involves incorporating and using a 401(k) as a shareholder of the business. All current retirement assets are collected into an account. There is no interest paid but the risk is high since business failure means losing entire life savings. Many entrepreneurs use this funding to buy a franchise, purchase equipment, or construct their storefront.
The Bottom Line
At the heart of entrepreneurialism are risk and potential. Using small business financing is a collaboration of the two. Whether just getting off the ground, waiting on customer invoices, or bouncing back from unforeseen circumstances, using debt financing can keep your business moving forward. The old expression you ‘have to spend money to make money’ rings true.
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