How to Finance a Small Business
So, you have a good idea for a new business, you’ve curated a business plan to its smallest details, and you have the mindset to succeed. The only problem now is where to get the funds to get started.
According to Small Business Trends, 82% of new entrepreneurs acquire startup business financing from their savings through loans from family and friends. Unfortunately, many mainstream lenders aren’t very keen on lending thousands of dollars in capital for a startup business. For them, it’s a huge risk to take because startup businesses haven’t proven anything yet.
Whether you like it or not, any new business always comes with a risk. This is the risk that banks don’t want to deal with. And if you’re thinking along the same lines as well, you might also have the unspoken fear of losing all that you have if your business fails. This leaves new entrepreneurs at a conundrum: where and how does one acquire a startup business loan?
What many people don’t realize is that startup business loans come in several types. You can borrow against your business credit, take personal loans, apply for small business loans, and even borrow against your home equity and retirement. That means to say that there are actually several financing sources for startup businesses, and you need to figure out which ones would work best for you.
Top Options for Startup Business Loans
SBA STARTUP LOANS
The Small Business Administration of the US government has a couple of financing options for new entrepreneurs, including the SBA Startup Loans. Their flagship program, the SBA 7(a) loan, is an excellent way to borrow money at low interest and longer repayment terms, making it more affordable for borrowers to pay their monthly installments.
The Small Business Administration works as a guarantor for borrowers, but financing actually comes from banks and financing institutions. The loan does not come from the SBA itself. With that said, the SBA has some stringent requirements, making it a lot more challenging to qualify for compared to business credit cards and personal loans.
But the good thing about the SBA 7(a) loan is that it can lend you a significant amount, even up to $5 million, and guarantees the loan issuer a good percentage (ranging from 50% to 85%) of the loan amount. Banks see borrowers qualifying for an SBA loan as less-risky because they have the SBA to back them up.
Now to qualify for the SBA 7(a), you need to have a business registered as a for-profit. You must also have been operating at least for a few years and has invested a portion of the funding from your savings and money. Although the guidelines may seem to limit to new businesses, you can still acquire an SBA 7(a) if you meet the above guidelines and you can present a comprehensive business plan, you have collateral and good personal credit.
If you don’t have the immediate cash to invest money into the startup, you could look into getting a ROBS plan, and then apply for an SBA 7(a) loan.
ROBS (Rollover for Business Startups)
Many entrepreneurs take advantage of their retirement accounts in funding their small startup businesses through ROBS or the Rollover for Business Startups. ROBS, however, is technically not a loan, but an investment. You don’t get penalized for early withdrawal, and you don’t have to pay it back as well. It also doesn’t come with the high-interest rates that so many lenders impose.
But ROBS is not for everyone. First of all, to qualify for ROBS, you need to have at least $50,000 in your IRA or 401 (k) retirement plan. Your business also needs to be a C Corporation, not an LLC or sole proprietorship. Additionally, you also need to pay some hefty fees to have the rollover successfully. If you’ve successfully established a ROBS plan, you can now use some of your retirement money to purchase shares from your company, which in return, can be used as capital for your promising startup.
SMALL BUSINESS CREDIT CARD
An excellent way to establish the capacity of your business’ purchasing power is through a small business credit card. A small business credit card is a convenient way to fund up your startup because 1). It’s a lot easier and faster to qualify for 2). You can keep a separate credit account for business and personal spending.
Most banks and credit issuers would require you to provide your business’ financial information when you apply for the small business credit card. In the case of a startup which has not started generating any real profit yet, you can indicate your personal credit history to show the issuer that you have been dependable with your payments on the past. It also helps to maintain a healthy credit score to establish your creditworthiness further.
And perhaps the best thing about owning a small business credit card is that you have a revolving line of credit which can help your business tide over unexpected expenses. As long as you keep spending below the max credit and you pay your balance responsibly, getting a credit card for your business has its perks. It further helps feed positive information to your credit history, and with the right card, you could enjoy miles, points and other rewards.
But that’s not to say that the small business credit card is cheap. Its interest rate is way more expensive than traditional business and personal loans. However, you can apply for credit cards with 0% introductory rate to enjoy cash-free use for a certain period. After which, you need to be very careful in charging your credit card. Pay your bills promptly and use up to the recommended ratio and your credit standing should be just fine.
SMALL BUSINESS MICROLOANS
Small business microloans are another forms of viable startup financing, mainly available to borrowers who may not qualify for business credit cards and SBA startup loans.
Microlending started in developing countries as a means to help budding entrepreneurs launch their businesses in smaller economies. Microloans have become very popular around the world and today; there’s a good number of microloan lenders in the US.
Microloans allow entrepreneurs to borrow small amounts like $500, and can even up to $50,000. The average microloan in the country is $10,000. Therefore, whether you only need a small amount to supplement your cash at hand, or a relatively huge amount to make up most of your business capital, microloans can prove to be a good option.
Compared to traditional business loans, microloans have less stringent qualifications. Lenders typically look at the industry the borrower operates in, and they also take into account the goals and projections of the business. They don’t put as much heavy emphasis on credit score, but rather on the potential of the company to grow and expand.
If you believe microloans are the best financing options for your startup, do your due diligence. Find microloans lenders who are a match with your business objectives. It also helps to draw up a comprehensive business plan for the lenders to check and determine your eligibility for the loan.
Personal loans are another lucrative financing source. Taken from a bank, credit union or online lender, personal loans are not limited to personal expenses alone. These loans are very flexible, and you can use them for basically anything, from your day-to-day expenses, to fund your business, rent new office space, purchase equipment or jumpstart your marketing strategy.
The good thing about personal loans is that they are highly accessible. These loans are unsecured, so they won’t require collateral, and are available to a wide range of borrowers. There are even lenders offering personal loans to people with bad credit.
Also, personal loans offer lower interests than credit cards. They may come in a lump sum loan, or a revolving type. Additionally, these loans come with fixed monthly payments, typically ranging from 2-5 years.
It is essential to note though that personal loans take credit rating and income into account. It is best to strive for the highest possible score and include other sources of income (such as salary from your day job or income from rental properties) when you apply for personal loans.
LOANS FROM FAMILY AND FRIENDS
Well-meaning family members and friends who believe in your startup business might be willing to lend you some money to get the enterprise off the ground. Indeed, this would come as good news, particularly when banks and mainstream lenders reject your loan application. Additionally, it may be easier to negotiate with family and friends when it comes to the loan’s interest rates and terms.
However, you want to borrow from friends and family with care. They are more likely willing to lend you money at a personal capacity, not at a business level. They want to see you succeed with your business. But when things go wrong, you may face personal and legal complications, so it’s best to determine whether or not you need to borrow, and if you do, how much.
Work out how much you need to borrow by creating a detailed business and financial plan. You don’t want to borrow too much as this is still a loan you need to repay, and you don’t want to borrow a little lesser as you’ll still need to fill in those gaps. When you’ve rounded the right amount, it becomes easier to justify your need for the loan.
You could also consider offering something to the lender, such as equity or percentage of the profits. This way, he will have the peace of mind that you’ll somehow pay the loan back. It is also most important to get the loan into writing, and have all parties sign the document. You just want everyone to be on the same page and that all of you understand the loan agreement.
Finding money to fund your startup business can seem daunting, especially if you don’t know what your options are. But upon closer inspection, you’ll find that you actually have a lot of choices, from your savings, personal loans, microloans, SBA startup loans, to borrowing from family and friends.
You need to remember that whatever road you take, you need to be careful in handling both personal and business finances. Figure out how much you need, how long you think it will take to repay the loan, and whether or not the loan is within your financial capacity to pay back.
Plan ahead, make projections but be honest with yourself. This is the first, biggest hurdle you’ll probably face as an entrepreneur. Figure out what works best for you, what’s most suitable for your business and your financial goals, and soon enough, your business should be on a roll.
Cary Silverman is a consummate entrepreneur having sold multiple companies during his 20 years of business experience in the financial industry, but for him, it isn’t about the money. His success is rooted in his passion to focus on doing something better today than it was done yesterday. These days, he’s the CEO of Waldo General, Inc. that oversees the operation of King of Kash.