5 Ways You Can Finance Your Small Business
April 10, 2014
Starting, expanding or maintaining your business takes money. If you’re lucky, the cash you earn will be all your business needs. If you’re like most business owners, though, there will be times when you need resources to finance your small business.
If a client’s check bounces or if you land a big project and need to staff up—you could be stuck if you don’t have funds lined up in advance. You might be able to find quick money from personal savings, or family and friends, but the hassle and stress of that can take its toll. It pays to take a strategic approach to making sure your business has money when it needs it.
Here are five ways small business owners are finding financing these days—starting with the more traditional options and ending with some newer options that are catching on. Each option has its own pros and cons, so be careful to choose the right financing strategy for you.
1. Small Business Loans
The bank is your traditional go-to place for financing. Only 10 – 15% of loans get approved these days, so you’ll want to do everything you can to improve your chances of getting the bank’s help. One way to do that is to create a solid business plan first. Your bank is going to want to see it.
Your business plan should describe your vision, strategy, goals, product or service, competition, management team, employees, advisors, the amount of money you seek and what you intend to do with it. Make sure you have done your homework before you visit your bank with your plan. You should understand marketing, your product or service placement in the marketplace, and the demographics of your chosen business area.
Most financial institutions have small business advisors that can assist you with writing a business plan. Some, such as Scotiabank in Canada, have an online tool to guide you through the process of writing your plan, which you can then share electronically with the bank. The Canada Business Network also provides information on preparing a business plan.
2. Government Programs
Lots of small business owners turn to the government for financing. Here’s a quick tour of some resources in the U.S. and Canada.
In the U.S., the U.S. Small Business Administration offers small business owners access to capital through loans and venture capital. Loans include the Export Express Program and the Working Capital Program. The SBA website also provides entrepreneurial development, government contracting, advocacy for small business and help in preparing a business plan.
In Canada, through the Canadian Small Business Financing Program, the government shares the risk of lending to small business owners with financial institutions. Applications are made directly to chartered banks, credit unions and caisses populaires, and small business owners may receive a maximum of $500,000 to establish or improve their businesses.
The Business Development Bank of Canada (now known as BDC) is dedicated exclusively to entrepreneurs. It offers long-term loans for projects and working capital, as well as consulting services, various financing options, and venture capital.
3. Revolving Lines of Credit
A line of credit is a good option for many freelancers and entrepreneurs to cover short-term needs. There are essentially two types: personal and business.
To qualify for a line of credit, be aware that business credit rates and limits are assessed on your business and its performance, while personal credit lines are based on your personal income and assets, and your credit history.
There are many uses for a business line of credit, from plugging temporary cash flow gaps to buying inventory to funding accounts receivables.
A personal line of credit can be handy for covering the “famine” part of the freelancer’s “feast or famine” cycle.
However, be advised: Although lines of credit carry lower interest rates than credit cards and are easy to dip into, financial advisors caution against using them extensively. If you’re trying to finance a major purchase or expansion, a business loan is a better option. With a personal credit line, you also have to be careful about commingling personal and business expenses. That can have tax implicatons and affect a credit rating. Best to check with a professional to ensure you’re using a line of credit properly.
4. Home Equity Loans and Second Mortgages
If you own your home, you may want to consider a home equity loan or second mortgage. The main benefit for this type of small business financing is that it can be a less expensive way to borrow, as interest rates are lower. For example, in Canada a government-guaranteed business loan carries an interest rate of prime (currently 3 per cent) plus 3 per cent, for a total of 6 per cent, while a mortgage can be secured at prime rate alone.
To qualify for a home equity loan or second mortgage you need a steady personal income. This type of financing is better suited to someone who has a steady job and is building a business on the side, or has an established business already. You also have to assess your level of comfort with borrowing against the security of your family home.
5. Alternative Financing Options
Beyond the more traditional financing options just covered, several alternative options are available these days. For example, many small business owners are successfully securing term loans from alternative lenders, such as Kabbage, OnDeck and IOU Central. Terms for such loans might range from one year up to 10, or longer. Interest rates are typically higher than what a bank would offer, but for many businesses that need the money, the price is worth it.
Businesses that have credit card or debit card sales are approaching merchant cash advance lenders for funds. Such a lender will typically give the business a lump sum payment in exchange for a percentage of future sales from credit/debit cards.
A growing financing option for entrepreneurs is something called factoring, which provides you with advances on your invoices. Here’s how it works: your business sells its accounts receivable to a third party, or “factor,” at a discounted rate. So, for example, if XYZ company owes you $10,000, the factor will take ownership of the receivable and give you a lesser amount, such as $9,700, now. Later, the factor will collect and keep the full $10,000. Some companies give a certain percentage to the customer right away, and the full amount when they collect in full.
Take note that factoring is a more expensive method of borrowing than a business loan, since factors generally charge more than banks. However, in some situations, the risk of not being able to pay employees or suppliers—or even shutting down—will make this the right strategy for some small businesses.
Another alternative is a service that lends a small business money against their receivables. For instance, a company like Fundbox will pay you the full amount of an outstanding invoice up front in exchange for weekly payments over twelve weeks for the full balance (invoice amount plus a small clearing fee). It’s up to you to collect from your client and you’ll have the convenience of getting money into your business fast, and—unlike traditional factoring—you don’t have to worry about a third party chasing your clients for payments.
Instead of being caught off guard the next time you need money to solve a cash crunch or take advantage of a great new opportunity, take the time to consider these financing solutions and what might be best for your business. Your accountant, small business advisor and/or lawyer can help you choose the strategies that make the most sense for you.