Figuring out how to raise money for a business is no easy feat, but don’t let it deter you from pursuing your passion as an entrepreneur. There are more than 30 million small businesses in the United States, according to the Small Business Administration (SBA). Behind many of these businesses is a founder or owner who navigated the many financing resources available and decided on the right type of funding for their companies.
You can do this! Before you hit the ground running in pursuit of funding, compare the most common options for financing a small business.
When you think of how to raise money for a business, your mind may go directly to a business loan. There are many options in this category. For example, the SBA offers guarantees to small businesses. Business owners can apply for a small business loan from a bank and potentially have the loan guaranteed by the SBA, meaning that if you’re unable to repay the loan, the SBA may pay a portion of the balance to the bank. This reduces the risk for both the borrower and the lender, which is partly why the SBA is so crucial to our country’s economy. Read more on SBA loan guarantees.
The Federal Reserve’s 2019 Small Business Credit Survey found that 43% of small businesses applied for a loan last year. The average small business loan amount is $633,000, Federal Reserve data shows. On average, loans backed by the SBA amount to $107,000, according to the SBA.
Securing a business loan from a bank can be difficult for a new business owner lacking any combination of business credit history, company trajectory, or collateral to secure the loan. Microlenders may offer smaller and shorter-term loans, usually under $35,000, to owners who can demonstrate a clear business plan, structure, and statement of intent. According to NerdWallet, these lenders may also offer consulting and other business services. Learn more about microlending in this article from Investopedia.
In addition to microlenders, online lenders are also becoming increasingly popular, accounting for 32% of small business loan applications in 2019 (up from just 19% during the three years prior), according to the Federal Reserve. Online lenders are also sometimes referred to as alternative lenders, as their requirements are often less stringent than those of traditional banks and credit unions. The difference between online lenders and microlenders is that online lenders may offer larger loan amounts.
Any time you seek a business loan, it’s best to consult a financial professional who can explain the benefits, drawbacks, risks, and requirements associated with the option(s) under consideration.
Business Line of Credit
Another form of business lending is a line of credit. While a business loan deposits a lump sum into your business bank account, a line of credit functions similarly to a credit card in that you have access to money when you need it, without having to borrow it upfront. With a line of credit, you only repay what you use. The interest rate on a line of credit may potentially be lower than that on a loan, but as with everything, this will vary.
A business line of credit often serves as a buffer for cash flow, one of the silent killers of small businesses. A U.S. Bank study found that 82% of businesses that failed cited cash flow problems as a factor in their failure. Essentially, they either ran out of money to support operations or had money going out faster than it was coming in. Like with any form of credit, the key with a business line of credit is to use it responsibly and pay it off promptly so you’re not carrying an ongoing balance subject to interest.
Struggling to qualify for a small business loan or line of credit or simply looking for a more creative route to raise money besides going through a bank? Maybe random strangers will help. Some have turned to crowdfunding to help fund their businesses. When you set up an online crowdfunding campaign, it allows everyday people—and likely some business people, too—to help fund your business by giving whatever dollar amount they can commit to comfortably.
The potential is eye-popping when you look at the stats, but successful crowdfunding requires more than simply composing a campaign on Kickstarter, GoFundMe, or other crowdfunding platforms. Speak with a professional before getting started with crowdfunding to decide if it’s the right option for you.
The TV show Shark Tank has done a wonderful deed for the general public in giving a glimpse into the process of finding an investor for a business. It gives entrepreneurs a chance to see how esteemed investors decide on which businesses to back. That said, getting an investor is certainly not as easy as the show sometimes makes it look.
The first thing to know about investors is that they’re not all the same. Angel investors are individuals with high net worth who invest their own money, similarly to the investors on Shark Tank. Venture capitalists, on the other hand, are associated with firms that manage pooled money from investors. Every investor brings their own motivation, strengths, processes, and terms.
Whether you’re presenting to angel investors, venture capitalists, or both, your business pitch will be pivotal. Components of a successful pitch include a market opportunity, compelling data, a defined brand, milestones, and, of course, a breakdown of how an investor can gain a return. Just as much, if not more, than the other business funding ideas laid out above, consulting an advisor is highly recommended before engaging potential investors in your business.
Family, Friends & Personal Funds
Business loans, lines of credit, crowdfunding campaigns, and investors have something in common: They all hinge on people you don’t necessarily know. So let’s wind down this list of small business funding basics with options you may find more approachable:
Family: While this may or may not work for you, several businesses take this route. One report—a small, but telling survey of 1,000 startup owners—actually suggests that family funds account for slightly more small business funding than bank loans.
Friends: It might be difficult to ask your friends for money, but it might work for you. A 2010 survey by the Global Entrepreneurship Monitor found that 5% of U.S. adults had invested in a company started by someone they know.
Personal Funds: Lastly, there is always the option to bootstrap your business, meaning fund it with your own money. This can work well if your business doesn’t require a large sum to operate and/or you have a job that you can continue working in during the early stages of starting your own business.
One survey showed that the lion’s share of small business funding—66.3%—came from entrepreneurs’ personal finances, including savings and income from a current job. If you can make bootstrapping work and accept a level of risk, you will be able to keep your small business funding in your control without involving outside lenders or investors.
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