If you are considering starting a business, you are likely to be aware that it can be a costly process. So, it is important that you have your funding in place. Unfortunately, this is where things can get a little overwhelming as there are a number of different funding options.
Determine How Much Funding You’ll Need
Before you can start to explore the different funding methods, you’ll need to have an idea of how much you’ll need to start or expand your business.
Costs to Consider
Payroll
Assess how many employees you currently have or will need for your business in the next six months. Add up what you will pay them for your total payroll cost.
Bear in mind that small businesses will not always stay small, so in addition to how many people you need initially, think about how many you will need before you start hitting your profit mark. Don’t forget to include if you’re going to pay yourself. While you’re building your small business, you will need to cover your own personal expenses.
Insurances
Depending on your industry, there are likely to be a number of mandatory insurances you’ll need for your business. You may also opt for additional coverage, such as health insurance for your employees. Get quotes for all the insurance policies you’ll need.
Permits, Licences and Taxes
You also want to make sure that your business does not run into legal issues, so you need to know how much capital you’ll need to cover your permits, licenses and taxes.
Premises and Utilities
If you need a physical space for your business, you will need to cover the cost of your lease and the utility costs. Before you sign a contract, make sure that you understand the terms of your commercial lease.
Equipment
You are likely to need equipment to operate your business. From phones and computers to machinery, you will need to think about the purchase or leasing costs. Don’t forget that you may need equipment to comply with the health and safety requirements of your industry.
Inventory
Will you have sufficient raw product to be able to operate? Will you need to invest in more before you start to make a profit?
Website and Advertising
You will need to promote your business with a good website and advertising. This could include social media ads, traditional marketing and other promotions, which will all cost money.
Types of Funding for Business Owners
As we touched on, there are multiple avenues of funding for business owners. Whether you are a new start up or looking to grow your small business, there is no one size fits all solution. Some funding can work better at different stages of a small business, while in some circumstances, it may work better to have a combination of funding.
Common Business Funding Options
| Type of Funding | Description |
|---|---|
| Personal Savings | Using your own money to fund your business. This is often the first option for entrepreneurs. |
| Friends and Family | Borrowing money from or receiving investments from close personal connections. |
| Bank Loans | Traditional loans offered by banks, often requiring strong credit and a solid business plan. |
| Small Business Administration (SBA) Loans | Government-backed loans for small businesses, offering lower interest rates and flexible terms. |
| Business Lines of Credit | Flexible funding allowing businesses to draw from a set credit limit as needed, paying interest only on used funds. |
| Angel Investors | Wealthy individuals who provide capital in exchange for equity or convertible debt. |
| Venture Capital | Investment from firms or funds in exchange for equity, typically for high-growth startups. |
| Crowdfunding | Raising small amounts of money from a large number of people through platforms like Kickstarter or Indiegogo. |
| Grants | Non-repayable funds typically provided by governments or non-profit organizations for specific purposes. |
| Invoice Financing | Borrowing money against unpaid invoices to improve cash flow while waiting for customer payments. |
| Merchant Cash Advances | A lump sum provided to businesses in exchange for a percentage of future sales or revenue. |
| Equipment Financing | Loans or leases specifically for purchasing equipment, with the equipment itself serving as collateral. |
| Revenue-Based Financing | Investors provide capital in exchange for a percentage of monthly revenue until the investment is repaid. |
| Bootstrapping | Building a business using limited resources and reinvesting profits for growth. |
| Peer-to-Peer (P2P) Lending | Borrowing money from individuals via online platforms that match lenders with borrowers. |
| Equity Financing | Selling shares of your business to raise capital, often involving giving up a portion of ownership. |
| Corporate Funding | Partnerships or investments from larger corporations to help develop or expand your business. |
A More In-Depth Look
Self Funding
Self funding or as it is more commonly termed, bootstrapping, refers to leveraging your own finances to support your business. This could take the form of using your savings, tapping into your 401k or even turning to family and friends.
Of course, you will need to ask yourself if you can afford to invest your personal funds and if you can raise enough to meet your needs. However, self funding will allow you to have complete control of your business. While you will take on all of the risk, you won’t need to adhere to the terms and conditions of a finance company.
Just bear in mind that you will need to carefully assess your finances, as you could damage your ability to retire or suffer hefty fees and penalties if you tap into your retirement accounts early.
Personal Loans
If you have great credit and are starting a new business, you could consider taking out a personal loan. This is perhaps the simplest way to fund your business, as you can typically use the money from a personal loan for almost any purpose. However, there are some serious potential drawbacks, including that your personal credit will be seriously impacted if your business fails.
Traditional Business Loans
If you’re a new business owner with no credit history, you may still qualify for a traditional business loan. Traditional lenders will consider your personal credit and if they find you have a good risk profile, you may qualify for a reasonable rate.
Once you’ve been operating several years and can show your business is established, you can access even better rates.
Online Business Loans
If you don’t have an established business or a great credit score, there are online lenders offering business loans. As with personal loans, online lenders tend to have more flexible lending criteria compared to traditional lenders, so this can be a more viable option.
In fact, in a 2020 Federal Reserve Small Business Credit Survey, 22% of the business owner respondents stated that they had applied for funding via an online lender.
Microlending
Microloans are very small loans that are typically $50,000 or less. However, what makes these loans different is that they are issued by individuals rather than a traditional lending institution. You can also find microloans through government organizations and non profits such as the Small Business Administration.
Angel Investors
An angel investor is an individual with a high net worth, who will get an equity stake in your business in return for providing financing. Angel investors expect to make a profit and typically will have business expertise that they are willing to share to help you grow your business.
There is no hard and fast best way to find potential angel investors, but there are angel investment networks and angel groups where you can meet and engage with potential investors. You can also attract investment via social media and networking events.
Just be aware that angel investors will often want to scrutinize business plans, so you will need to have a case prepared as to why your business is a good investment.
Venture Capital
Venture capital investment is typically offered in exchange for an active role in the company and an ownership share. Essentially, you’re getting a capital investment rather than a debt, but venture capitalists often focus on high growth companies.
At a minimum, a venture capitalist is likely to want a seat on the board of directors of your business, so you will need to be prepared to relinquish a portion of ownership and control of your company to obtain your funding. You will need to perform your due diligence, so you’re fully aware of what is expected of you and your company, and be comfortable with the terms before you sign any agreement.
Crowdfunding
Although it seems like a very new idea, crowdfunding is a well established way to raise funds. Many of the modern day platforms have been around for almost 20 years.
Essentially, you will pitch your business idea on your chosen platform or site, such as Indiegogo or Kickstarter. You can then get upfront pledges you can use to fund your product or business. You’ll be raising the funds you need from a large number of people or crowdfunders, who all pledge smaller amounts. You can usually set tiers, with each one offering different rewards or gifts as a thank you for the contribution. So, while you will need to cover these costs, the crowdfunders don’t expect to get a financial return on their pledge.
Often the crowdfunding gift is the product you plan to sell or a special perk. This could be something like a thank you on packaging or free product.
This is a low risk form of business funding, as you can raise the funds you need while retaining full control of your company. Additionally, if the plan fails, typically you are not obliged to repay the crowdfunders. However, you will need to market yourself properly and be web savvy to attract crowdfunders. You also need to read through the terms and conditions of your preferred platform, so you know the full legal and financial obligations before you sign up.
Invoice Factoring
Invoice factoring involves selling outstanding invoices to a specialist factoring company. The invoice factoring company repays the business a percentage of the invoice total, which is typically 75 to 90%, almost immediately. When the invoice has been paid in full, the factoring company pays you the remainder of your invoice less a factoring charge or fee.
Since this isn’t a loan, you don’t need to worry about repayments, but it can be a good option to help with cash flow as you don’t need to wait for your client to pay the invoice in full. Additionally, you don’t need to be concerned about your credit score, since the factoring company is more interested in whether your client has sufficient reputation to pay in a timely fashion.
Small Business Grants
There are a number of non profits, government entities and corporations who offer money to help launch or grow businesses. Some grants are open to any new small business, while others have a specific demographic focus. You can explore the options on a database website like grants.gov.
You can often find federal, state or local grants for small businesses in different industries and circumstances. For example, the Small Business Innovation Research Program or SBIR offers grants to small businesses with an ability to perform federal research, while the US Chamber of Commerce has Dream Big Awards each year that recognizes small businesses that have contributed to growth of the overall economy. There is a chance to win a grand prize of $25,000 by submitting an application.
Which Funding Method is Best for Your Business?
There is no clear rule as to which funding method will work best for specific types of businesses, but you can narrow down your options by answering some questions.
- How much do you need and what do you need the funds for?
- What level of debt can you afford?
- Do you have a preferred borrowing method?
- Will you need to make changes to be eligible for your preferred type of funding?
- What’s your personal credit score?
- Is your business operating now and how long has it been established?
- What’s your revenue?
- Can you offer collateral?
- Does your business idea and story seem like something that you would take to potential investors?
- Do you have a solid business plan that you can present to investors or banks?
Remember that the goal of funding for business owners is to benefit your enterprise, not burden yourself with debt. It’s important to choose the right type of funding that will fit your financial needs and help you to reach your business goals.
Tips to Make Your Small Business Attractive to Lenders and Investors
Whichever route you decide to take to fund your business, you need to ensure that your enterprise is attractive to potential lenders and investors. Luckily, there are some great tips to help guide you.
Write a Great Business Plan
Your business plan will be how you present your business to lenders or potential investors. A good plan will include something about your personal story and why you are passionate about your business.
You will need to do comprehensive market research to demonstrate that you understand the industry and where you want to take your business. You should also be able to back up financial projections with relevant data and provide a clear business model and marketing plan.
Boost Your Credit Score
As with personal finance products, before you apply for any funding, you will need a solid credit score. In some cases, this may be your business credit score or your personal credit score. If you have less than ideal credit, you should try to take steps to boost your score, by having incorrect entries removed from your credit report or paying down debt before you submit any applications.
You could also take it a little further with a business credit card. Opening a business credit card account would allow you to use the card regularly and pay off the balance to build your business credit. Just be sure to avoid getting into a debt spiral and aim to repay the credit card balance every month, so you don’t pay interest charges.
Crunch Your Numbers
Lenders and investors are taking a chance on any funding application, so they want to make a return on their investment, so you need to show the potential for profitability. You need to display the financial track record for your business, with your current cash flow and debt, along with sales. If you’re starting a new business, you need to create a clear plan of how you will achieve your business goals and when you anticipate being able to provide a return on investment.
Create Your Business Narrative
Whether you’re meeting with a business banking officer or a potential investor, they are likely to have heard countless pitches. So, while hard data and business analytics are important, you need to be able to stand out from the crowd. A successful pitch will sway the investor towards your business with a compelling narrative about what you’re pitching.
Create a strong story that explains how you conceived your business idea, your drives and passion about what you’re doing and the impact you intend your business to have. If you can create a compelling narrative, you have a greater chance of investors being willing to take a chance on you and your business.
Develop a Clear Investment Structure
Before they will part with any cash, investors want to know a clear layout of the investment structure. As an example, they will want to know any legal repercussions such as liability exposure if there is a problem. These issues can play a major role in whether or not they decide to invest. Would your investors be business partners or shareholders? If so, what degree of say will they have in any business decisions with you?
It is important to create an agreement that details the rights and obligations for your investors, which includes provisions should an owner wish to sell, the business ceases trading and other scenarios.
Starting a new business or expanding your existing business can be an exciting and scary process. There is lots to research and plan, but getting the right type of funding is a crucial aspect of this. It is worth taking some time to explore all the options of funding for business owners to find the one that best suits your circumstances, preferences and business requirements. Remember, you can always use a combination of finance methods to reach your goals, just be sure to fully understand the implications of your choices, so you can move forward with confidence. Whether you take on debt or connect with investors, getting your funding right is the first step on your journey to business success, so make sure that you get started on the right foot.