Nearly every small business requires financial assistance. From purchasing real estate and equipment to hiring employees, very few business owners have the capital to fund their businesses on their own.
What are your options? What are the requirements? Which type of financing is right for your business?
Most types of small-business funding fall under debt financing or equity financing.
As a small-business owner, it’s important that you understand the difference between these categories, which type of financing makes sense for your business, and how to secure funding.
Debt Financing vs. Equity Financing
Debt financing is what you probably first think of when you consider your financing options.
This type of financing refers to the process of borrowing money with the expectation that you will be able to pay back the amount that you borrowed plus interest. This includes term loans, credit cards, unsecured loans, and lines of credit.
On the other hand, some equity financing does not require you to pay back the amount that you raise. Instead, one method of equity financing allows investors give you money in exchange for partial ownership in your company.
Debt financing allows you to retain full ownership of your company; however, if you’re unable to generate profits, you might find yourself in severe financial trouble. Meanwhile, this type of equity financing does not require you to pay back any money, with the caveat that you will have to give up some control in your company.
Debt Financing Options
Debt financing gives you access to a number of options that can be used for various purposes. This includes equipment loans, disaster recovery loans, general business loans and more.
Bank loans are often the most difficult type of financing to secure. However, they are extremely practical and cover a wide array of needs, including helping jumpstart your business.
To secure a bank loan, you’ll need:
- Excellent credit
- A strong business plan
- An investment strategy
- Bank statements
- Demonstrated profitability
- And more
While bank loans often have strict requirements, they’re often preferable, as they tend to have low interest rates.
The Small Business Administration (SBA) offers a number of loan programs to help entrepreneurs. While the SBA does not provide these loans itself, it helps small-business owners secure financing by guaranteeing a percentage of the loan. SBA loan programs include:
Each of these loan programs is best -suited for businesses in different circumstances. For example, 7(a) loans can be used for anything from establishing a new business to expanding your business, while disaster loans are meant to help businesses recover after a declared disaster.
Eligibility requirements include that your business:
- Is a for-profit business
- Does business in the United States
- Has invested equity
- Has exhausted all other financing options
If your small business meets these requirements, SBA loan programs are a great way to secure low-interest financing.
Business credit cards are a great option for short-term financing.
Credit cards give you access to immediate funding for smaller expenses like a new computer or office supplies.
Just like a personal credit card, it is important to use business credit cards responsibly to avoid building extreme debt and ruining your business’s credit history.
Poor credit may reduce your chances of securing financing in the future.
Qualifying for bank loans and SBA loans can be difficult. If your business is in the early stages, and you don’t have the ability to demonstrate profitability or provide expansion plans, you might find it hard to be approved for a reasonable business loan.
As such, you may choose to pursue financing from an alternative lender. Alternative lenders typically have easier application processes, more lenient eligibility requirements, and fast processing times.
Keep in mind, though, that depending upon the lending method you pursue, interest rates might be higher, and you may only be able to borrow up to $500,000. However, this can be a great option if you aren’t able to personally fund your business and don’t meet the requirements for bank loans.
Equity Financing Options
Equity financing may be an attractive option, as you don’t have to worry about repaying investors if your business fails.
If you choose to pursue this method of funding, you’ll likely need to choose between two options: crowdfunding and fundraisers.
There are several types of equity investors, including:
- Venture Capitalists: Venture capitalists will typically offer very large investments in exchange for significant equity.
- Angel Investors: Angel investors are wealthy investors that have experience in your industry.
- Friends and Family: This is the first option many small-business owners choose when trying to secure financing. This usually won’t generate large investments but will help in the earliest stages of starting a business.
These aren’t the only types of equity investors but are some of the most common. Before your business is able to qualify for bank and SBA loans, these may be your only options for raising capital.
In addition to crowdfunding platforms like Kickstarter, which allow consumers to invest in businesses in exchange for rewards, there are equity crowdfunding options.
Platforms like Crowdfunder allow small businesses to pay to join their platform and raise capital from thousands of accredited investors.
Equity crowdfunding can be a great option for companies who need to raise money quickly. Keep in mind that equity crowdfunding can make it difficult to secure more investments in the future, as some investors may not want to invest in a company with too many shareholders.
Securing funding for a small business can be intimidating. There are numerous options and it can be difficult to decide which ones best suit your business. However, learning how to secure funding is a necessary step toward building a successful small business in any industry.
While these are not all the funding options available, they are some of the most common and meet many of the needs small businesses face in the early stages of development.