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The ultimate guide to small business funding

Read our guide on how to fund small businesses

Jon Davis · August 22, 2023
The ultimate guide to small business funding

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Whether you want small business funding to get a business off the ground or require an injection of cash to take your enterprise to the next level, it's crucial to understand all the small business funding options available.

Why? Because not every funding source will offer the same opportunities or risks. In short, it's worth learning about all the funding options available before simply taking the first one you encounter.

As a business owner, you should know the pros and cons associated with all small business funding options. Read on to find out how to get funding for a small business and learn about the commercial implications of each option.

1. Bank loans

Bank loans are among the moat common small business funding options. Their main advantage is the potential they offer for sizable funding. They allow small businesses to undertake larger projects, grow their customer bases and invest in capital equipment.

Historically, bank loans have offered low-interest rates, making repayments manageable. They're also a good way to secure startup funding for small business ventures, especially since many banks have specialized divisions devoted to new enterprises. Additionally, the regular payments afforded by bank loans aid budgeting and financial planning among SMEs.

However, bank loans can sometimes be hard to get. Banks need a strong credit history and you must also submit a solid business plan. In some cases, collateral - assets that can be seized if repayments aren't made - will be needed. In addition, loan application processes tend to be lengthy, requiring substantial paperwork.

Even if you know how to get small business funding from a bank and fulfill all their requirements, a bank loan may take a long time to come through.

This process varies from bank to bank, of course, and not all business bank loans are the same or require the same level of checks. Therefore, shopping around for the best one is important, so you'll have to factor this into your early commercial decision-making, especially if you're a heading up a startup.

2. Small business administration (SBA) loans

SBA loans are designed for business expansion. Such loans are supported by the US Small Business Administration. Enterprise Finance Guarantee (EFG) runs the government-backed equivalent scheme in the UK, while the European Union offers similar small business funding through its COSME program. SBA loans are often attractive due to their low-interest rates and long repayment periods.

Even better, they're available in different sizes, accommodating small businesses with different funding needs across numerous industrial sectors. SBA loans can stimulate business growth in new markets or are used to purchase equipment. In some cases, you can also apply for one if you need to expand your premises to grow your small business.

However, SBA loans aren't always easy to secure. Strict eligibility requirements can exclude specific small businesses, including most startups. In addition, the long-winded application process requires meticulous financial documentation.

In most cases, you will need professional support from an accountant to apply for an SBA loan. In the US, SBA loans typically require a personal guarantee or some form of collateral. If your business fails to generate sufficient revenues to repay the SBA loan, your assets will be at risk.

3. Business credit cards

Business credit cards give immediate access to funds. Relying on them for small business funding means being able to take swift action, such as purchasing stock that a wholesaler is currently selling off at a low cost.

In short, accessing funds without the delays associated with inward investments or bank loans allows entrepreneurs to capitalize on commercial opportunities and deal with unexpected expenses.

Another key benefit is the ease of procuring business credit cards. Also, many business credit card providers offer rewards and loyalty programs, such as cash-back offers or travel points. These programs can add considerable value to routine business spending.

However, the undoubted convenience of business credit cards can come at a steep price. The interest rates are typically greater than those of most business loans. Even worse, business credit cards have escalating costs if cardholders don't promptly clear their balances the month after the billing cycle.

Failure to make regular payments can harm your credit score and impede access to future borrowing requirements, even if you know how to get small business funding another way.

Although credit cards may help boost short-term cash flow, relying on them for operational costs is rarely advisable. It's crucial to use business credit cards judiciously and not just to cover systemic cash flow problems, which may result in undesirable debt spirals.

4. Crowdfunding

As a small business funding option, crowdfunding platforms provide access to a vast pool of potential investors. They're a good way to test how receptive the market is to your business proposal. Using them shows that your product or service is validated and viable, even before you launch.

As such, crowdsourcing startup funding for small businesses has become increasingly popular. In addition to funding, crowdsourcing can generate much-needed publicity for startups, thereby helping early customer acquisition among startups.

However, crowdfunding needs an engaging story and significant marketing activity to attract backers. Campaign management, including an in-depth knowledge of social media marketing, will be required to crowdfund your enterprise. Also, you'll need to be strong at communicating with your backers and fulfilling promised rewards.

Keeping up with this can be demanding, especially while focusing on getting the business up and running. Bear in mind that not reaching the funding goal you have set might result in receiving nothing from your backers, although this will depend on the rules of the particular crowdfunding platform you choose.

5. Angel investments

An angel investor is an individual who offers small business funding and much more besides. Typically, you'll also receive mentorship and networking opportunities from someone who has successfully run a business.

Angel investors usually have a high net worth. They exchange their expertise – and financial support – for a share of the business. Angel investors can sometimes provide industry insights and connections, leading to accelerated growth. Unlike lenders, they share the risk, as they don't expect repayment if the business fails.

Knowing how to get small business funding from an angel investor often means already having existing connections. One downside of this approach is that you may already be well-connected and, therefore, the business associations of your investors may be of limited value.

Also, this funding source is competitive. Many small business owners may be trying to attract an angel investor from the same group of individuals. If you don't have someone in mind, you may need time to find the right investor — time you could spend on building your enterprise. Moreover, equity is exchanged for funds with this model, leading to diluted ownership and, in some cases, the potential loss of control.

6. Venture capital (VC) funding

This type of small business funding can bring significant capital into your business. It's often sought after when rapid expansion is desirable. Venture capitalists don't just provide funds, however, they usually come with a wealth of industry knowledge and an extensive network of contacts.

Although similar to angel investments, VC funding typically comes from professionally managed firms investing large sums from pooled funds, not high-net-worth individuals. As such, VCs often only provide funding in exchange for equity in your business.

VC funding comes with its share of drawbacks, however. Typically, venture capitalists seek high returns on investments, usually through a business sale or an initial public offering (IPO). Of course, this might not align with the long-term vision you have for your business.

In addition, since VCs usually acquire significant equity in companies they invest in, making such a deal may impact the degree of control you have over business decisions. Also, the pursuit of VC funding can be difficult. It requires an impressive business plan and quantifiable signs of growth potential.

7. Personal savings

Utilizing personal savings for business capital is a popular funding option for many small business owners, primarily due to the autonomy it offers entrepreneurs. This method eliminates external influences on business decisions.

Equally, you don't need to know how to get small business funding from other sources if you self-fund. Ideal if you want to maintain full control over the direction of your business. There are no interest payments to worry about, either. Nor will there be any collateral to offer up and no stringent application requirements to meet, unlike with bank loans.

Furthermore, the simplicity of dipping into personal savings means no waiting for lengthy loan approval decisions. You can get your business plans underway without delay.

However, the most significant risk with this small business funding route is the potential for personal financial loss. If the business doesn't succeed, then your savings will be gone for good. Furthermore, the available funding is also limited to the extent of your savings. It might not be enough to support the level of business growth you're aiming for or to recruit the skills you'll need.

For some, self-funding may not be enough to sustain the business through tough financial periods. Moreover, lacking external financing may mean missing out on the business advice or networking opportunities that investors and lenders can provide.

8. Borrowing from friends and family

Borrowing from friends and family is an accessible, flexible method of raising capital for a small business. Interest rates, when applicable, tend to be low. Depending on the personal relationship with your investor, you may be able to adjust repayment schedules.

Like self-funding, borrowing from a friend or a family member often means you won't have to research how to get funding for a small business from a more traditional route. Therefore, borrowing from friends and family can save time, allowing you to focus on getting the enterprise off the ground.

However, the funds from friends and family might only be enough to fund a startup. For example, when a more significant investment is needed for tooling or expansion, funds might run out, requiring you to seek alternative small business funding options.

Another downside to this approach is the potential for strained relationships. If the business struggles or fails, it'll leave you indebted to a family member or a friend. Also, friends and family may want to oversee business decisions, which might undermine your entrepreneurial spirit.

Formalizing any agreement with friends and family with a proper contract is crucial when borrowing money to support your small business. Otherwise, managing expectations and avoiding undesirable disputes down the line can be hard.

9. Microloans from nonprofits

Charities and nonprofit organizations often provide microloans to help SMEs obtain the financing they need to grow their businesses. Due to the smaller sums involved, these credit sources are typically easier to secure than traditional bank loans. They often target firms with a limited credit history. As such, startup funding for small business ventures can often be obtained via microloans when other types of loans are unavailable. Some microloan providers in the US also offer entrepreneurial training or mentoring programs. These schemes can be advantageous for startup business owners with limited commercial experience.

However, the amounts available through microloans may not be sufficient for larger capital needs. If your startup business model or SME relies on significant sums to get going or grow, then micro-financing the company likely won't provide the solution you seek. Another drawback of these small business funding options is that the interest rates required to pay back microloans can be higher than traditional loans. Furthermore, repayment can still be difficult to meet if the business struggles, regardless of the loan size.

10. Invoice factoring

Invoice factoring offers quick access to cash tied up in unpaid sales invoices. As such, it tends to help established small businesses with cash flow issues rather than startup enterprises. This method can be a viable option to obtain funding for companies that offer clients long payment terms. In short, if your proposed creditor knows you're owed a substantial sum from your current client base, they may lend to you in the short term, factoring in the value of your currently unpaid sales invoices.

One downside to this approach is that it can be costly, as factoring companies take a significant percentage of the amount you have outstanding with your debtors. Furthermore, this method can lead to a dependency on the factoring service, which can be hard to break free from. Invoice factoring may demonstrate underlying cash flow issues with your business or a failure to have proper credit controls in place. Either way, the debt collection process is also likely to be transferred to the factoring company, which could impact your customer retention if they're not handled appropriately.

Picking the right funding is essential to grow your business

Knowing how to get funding for a small business requires exploring all the options and weighing up the pros and cons of each method. For instance, what suits a startup may not suit a well-established small business. In addition, some investment sources require a more flexible approach to business equity than others. As such, the price may be too high if you want to retain full control of your company.

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