Financing a Business: Evaluating Your Options
Financing is the lifeblood of a business. During good times, business financing can help entrepreneurs purchase assets, expand products and services, add a new location, and hire more staff. During more difficult times, business owners may require financing just to continue their current operations. A business may also be at the start-up phase and require capital to get off the ground.
Owners seek business funding for many reasons. But without access to the money they need when they need it, even the best business plan can fail. With myriad funding options available, businesses have their work cut out for them when deciding which option is the best for their needs. If you have questions about business financing, please reach out to our attorneys for personalized advice.
Types of Business Loans
According to a survey by the Federal Reserve, 37 percent of businesses sought financing in 2020, down from 43 percent in 2019. The COVID-19 pandemic has been more of a bust period than a boom period for many small businesses, but those that weathered the storm report record-high optimism heading into 2022.
Strong profit expectations could make this a great time to start a new business or invest in your existing business. Business owners looking for additional funding may be interested in exploring one or more of the financing options described below.
The first place you might turn to for business financing is yourself. Personal savings are an obvious source of funds. Still, since Americans are notoriously poor savers—nearly 70 percent of Americans have less than $1,000 in a savings account—it may be necessary to combine personal savings with other self-financing methods.
For business owners with good credit, one such method is a business credit card. A business credit card can be used whenever your business needs an infusion of cash. Look for one with a 0 percent introductory annual percentage rate (APR), and better yet, the ability to accumulate purchase points that can be reinvested in your business. Be careful not to rack up so much debt that it is difficult to pay it back. Credit card interest rates can be quite high after the initial APR period expires.
A traditional bank loan, or term loan, provides a lump sum of capital that is paid back over time with interest. The bank sets the fixed loan period (e.g., five or ten years), the interest rate, and the amount and timing of payments. It will want to see your business plan and will require some type of collateral for the loan. Consider working with a credit union or a local bank, which will allow you to work directly with someone on your application.
You may qualify for a Small Business Administration (SBA) loan through a participating bank. SBA-guaranteed loans reduce risk for lenders and are worth a look for businesses that have trouble getting a traditional bank loan. Several SBA loan programs are available.
Crowdfunding uses a platform such as Kickstarter or GoFundMe to raise capital from individual donors. While each crowdfunding site works a bit differently, the general model is the same: First, you set up a profile for your project. Next, create a pitch, set a fundraising goal, and ask for donations, usually with the pledge to return something of value to your donors (such as a discount code for a purchase or exclusive access to a business offering).
Crowdfunding tends to work best for products or businesses that have a large social media following. Be sure to read the fine print before launching a campaign so there are no surprises. For example, the platform may allow you to keep your donations only if you hit your fundraising goal.
Family and Friends
Your friends and family may have offered invaluable emotional support when you made the decision to start your own business. Now you can allow them to back your enterprise with financial support. Dealing with friends and family has obvious benefits. Your relationships have built-in trust, and friends and family may be more flexible and forgiving than institutional lenders. However, it can be tricky to work with members of your family or social network.
When going this route, try your best to maintain a professional relationship. Present them with a business plan, document the agreement in a legal contract, and uphold your end of the bargain. Be aware that managing the situation poorly could hurt not only your business but also your personal relationships.
Instead of turning to family and friends for business financing, consider professional investors. The two main types of investors are angel investors and venture capitalists (VCs). VC firms are businesses that invest in other businesses by purchasing ownership stakes in them. However, VCs expect a strong rate of return and are therefore selective about the pitches they accept.
As an alternative to VCs, angel investors are wealthy individuals or organizations that provide capital in exchange for equity or convertible debt. They usually offer smaller investments than VCs and finance early-stage businesses.
Because they have a stake in the firm and want it to succeed, VCss and angel investors typically provide mentoring and networking benefits in addition to capital. You can learn more about the differences between angel investors and VCs here. Check out the Angel Capital Association to find angels.
Small business grants provide free money to those who qualify. You do not have to pay back the money you receive from a grant, but eligibility criteria are strict. Federal, state, and local governments as well as corporations offer grants. If eligible, you can improve your chances of qualifying for a grant by exploring those that target certain demographics, such as women, minorities, and veterans. Fundera provides a detailed breakdown of available small business grants.
Other Business Financing Considerations
There is not a one-size-fits-all solution to business financing. As you explore financing solutions, keep the following points in mind to find the right fit:
- The amount of funding you need
- What the funding is needed for
- How quickly you require the funding
- Whether the capital infusion is a one-off or needed on a regular basis
- The types of loans and investments you qualify for
- Your willingness to give up some control over the business in exchange for an investment
- Legal issues for small business lending (including federal and state securities laws, consumer laws, licensing issues, electronic contracting issues, and Dodd-Frank considerations)
Sorting through the available loans as well as the loan terms, financing amounts, and eligibility criteria may present challenges for your business. Small business lending also has legal ramifications. If you have questions about business financing, know that our attorneys are available to help. Schedule a call to speak with an experienced member of our team.