It’s no mystery that small businesses often need additional working capital to operate and grow, but financing your small business can be an intimidating and time-consuming proposition, especially for first-time entrepreneurs. While millions of small businesses in the U.S. use outside funding options (up to 70%), less than half (48%) percent receive the amount of financing they need. It’s no wonder only 55% of small business owners would recommend their lending partner to a peer.
Business financing is a term used in reference to any way a business acquires capital (cash) to pay for operations, growth, or improve cash flow. In this guide, you’ll learn about all of the different options available to small business owners when it comes to funding those business expenses.
To grow and operate your business, you need cash, but where do you go to get it? What kinds of terms should you be looking for? It can be difficult to answer these questions, especially if you’re new to small business financing. It’s even more complex if you lack financial history or have poor credit.
The good news is that there are plenty of funding options for small businesses that fit a number of business profiles and needs, and new solutions seem to pop up all the time. Still, many business owners think they have only a couple of financing options—namely to borrow from a bank or to seek funding for a small business startup from investors. In reality, the right financing solution for your business depends on a number of factors, such as your business’s funding needs, your credit score and history, and other qualifying factors.
To simplify your financing decisions, we’ve outlined 16 small business financing options that range from traditional bank loans to lesser-known alternatives. Each option addresses different business needs and offers advantages and disadvantages, which are summarized below. This comprehensive list of small business funding solutions includes credit-based and equity-based options, as well as links to resources and examples of funding solutions.
Armed with this knowledge of your funding options, you can make the right decision for your small business.
Small business lending through traditional banks is popular largely due to familiarity. You’ve likely worked with them as a consumer. You’re aware of how credit works and how to take out a loan. But before you choose a business lending option, you should know the differences between them and how they affect your credit, your time, your business, and your bottom line. A bank loan, regardless of which kind of bank you use, is best suited to businesses with good credit scores, collateral assets, and a positive cash flow history.
What is a term loan? In general, a term loan has a specific amount and a repayment schedule that lasts anywhere from one to 25 years. The interest rate on a small business term loan can be fixed or floating (changing). These loans are mostly used for capital-intensive spending, like buying equipment or a building, but they can also be used for ongoing expenses.
To secure a small business term loan, you’ll need to decide exactly what you’ll need the money for, how much you’ll need to borrow, how long you’ll need it. Before you apply for a term loan, you should gather your business and personal finances, check your credit score, and if applicable, create a business plan to prove you can pay back the loan. You might also need collateral to secure the loan, especially if you’re borrowing for over a year. Shop around to see what terms different banks are offering.
You can get some of the lowest interest rates and flexible repayment terms with term loans.
Borrowers must have very good credit and a solid business history and profitability in order to qualify for term loans. The application and approval process can take a few months. Additionally, due to bank policies, there may be penalties for early repayment of the loan or for not using the entire amount.
Term loans are a viable option for small businesses who have good credit and a business history and who do not need immediate cash.
Revolving lines of credit (LOCs) are flexible loans that, once approved, allow you to borrow up to the approved limits at any time. You can then borrow up to the credit limit again without having to go through another loan approval process once you repay some of the principal. You will pay interest on the amount you draw down. These credit facilities can be obtained via the traditional bank loan application process, through online banks, or the Small Business Association (SBA).
You can quickly and easily fund a temporary or seasonal uptick in cash needs with a small business line of credit. The line enables you to borrow flexibly to cover costs, such as increased inventory or longer payables terms, paying interest only. You can then repay the line quickly when your receivables are collected.
The lending bank often requires any balance on the line to be paid off by the end of each predetermined billing cycle. If the balance is not paid off, late fees and interest accrue against the unpaid balance, and are often very high. In many cases, collateral may be required to secure the line. The lender may also call the loan at any time, which can put your business at risk if you don’t have immediate cash to repay the balance.
A revolving line of credit for small business is best when you need flexibility in borrowing from month to month to meet cash shortfalls and can repay the debt in a timely manner. As with term loans, you will need good credit and possibly collateral.
Commercial mortgages for small business are secured loans that finance new business property purchases such as a warehouse or office, or serve to refinance an existing business mortgage. These loans are usually secured against the property they fund. You can get a commercial mortgage from a bank or from a specialist lender. Banks usually offer better interest rates but are harder to secure mortgages from.
Securing property for your business that increases in value is the main benefit of a commercial mortgage. A commercial mortgage also saves you overhead costs such as rental and rent increases, potential business moving costs, and unfavorable lease terms. You can also rent or sublet a part of your property to generate cash flow. The interest on these loans is also tax-deductible.
The main challenge with commercial mortgages is the large upfront downpayment you will need to make to secure the loan and the arrangement fees of 1%-2%. Commercial mortgages usually require that your business has at least a three-year operating track record.
If you need to secure a long term operating space, have the ability to fund a downpayment, and have been in business for a few years, commercial mortgages are a good option for mitigating future costs and risks.
These loans are used to fund the purchase or lease of commercial equipment, such as factory machines, office furniture, or special purpose equipment. Like other loans, you must make periodic payments (interest and principal included) over a fixed term. A lien against the equipment being financed is usually required by the lender.
Equipment financing for small business saves a large cash outlay when critical equipment fails or requires an upgrade. In many cases, it’s the easiest way to pay for equipment required to expand your business. As with other loans, rates and terms vary from strict (banks) to more flexible (online lenders).
Financing equipment will cost you more than paying cash outright. The lender may impose a lien upon some of your other business assets or require a personal guarantee. Failing to repay your loan could result in the repossession of your personal and business assets by the lender.
If you’re expecting to need some expensive or additional equipment and have decent credit but are short on cash, it makes sense to explore equipment financing for small business.
An overdraft agreement is a loan which allows you to have a negative balance on your bank account. You pay a fee for this service, interest on the overdraft amount, and you are required to repay the loan under the terms and conditions stipulated in the agreement.
This type of loan allows you to essentially borrow up to a certain limit without requiring any further discussion with the bank. It can bring peace of mind when unexpected expenses or cash shortfalls occur.
The bank may ask for security in the form of collateral and may also charge daily interest.
While you don’t want to rely on an overdraft loan agreement for regular funding of your small business operations, it can provide a safety net for unforeseen cash shortfalls.
As a small business owner, you’ve probably heard of Small Business Association (SBA) loans. These loans are geared towards supporting small businesses across the US. Issuing banks face a lesser lending risk with SBA loans. This is because these loans guarantee a portion of your borrowings. An SBA loan can be applied for through credit unions, local banks or any approved financial lenders.
There are numerous types of SBA loans, and they can range anywhere from thousands to millions. They can be used for various small business financing needs which might include:
SBA loans can be a great solution for businesses who don’t qualify for a traditional bank loan. They’re also more affordable because of their interest rate caps. Fixed asset loans are collateralized by the asset, so there’s no need to commit personal assets. Additionally, the SBA offers a lot of free education and business information to small business owners.
Like bank loans, obtaining loan approval can be hard and takes a long time—usually at least two months. In order to get a larger loan, you’ll need collateral (usually personal assets) and a downpayment, so you need very high confidence that you can pay it back. If you have poor credit or limited financial history, it’s unlikely you’ll be approved.
A small business loan is a good option if you didn’t qualify for a traditional bank loan or want better terms, and if you have a solid business history and the time to invest in the process.
Community Development Finance Institutions (CDFIs) provide funding to small businesses and startups and are certified by the US Department of the Treasury’s CDFI Fund. They mostly focus on providing funds to businesses in underprivileged communities targeted by the federal government. There are four types of financial institutions in this category: CD banks, CD credit unions, CD loan funds, and CD venture capital funds.
To obtain a community development loan, you need to be able to demonstrate that you are part of the community they serve.
If you have a poor credit score and have an explanation, CDFIs will consider that and other circumstances when deciding whether to lend money. Usually, CDFIs do not require nearly as much collateral as banks do and offer reasonable interest rates. Additionally, some CDFIs offer local office space and on-the-ground business support, as well as a strong commitment to helping small businesses they fund to succeed.
Applicants must meet the requirements for the community that the CDFI serves, and still need to go through a typical credit application process and provide documentation. Since CDFIs coordinate funding from private sources, they may charge higher interest rates and fees than banks.
You should consider CDFIs as an alternative to traditional financing if your credit scores are not great, you have little collateral, and you are part of an underserved, underfunded community.
Nonprofit microloans are exactly what they sound like. These are small loans, usually from $5,000 to $100,000, that are offered to entrepreneurs and very small businesses who often don’t have collateral. They often cover basic operations and working capital to buy inventory, furniture, and supplies. Many nonprofit lenders target special interests, such as minority-owned businesses, specific industries, or underserved areas. Microloans are also available from government-sponsored agencies like the SBA and the USDA.
If you need a quick injection of cash or startup funds but have no collateral or poor credit history, microloans are a possibility. Additionally, these loans usually have a lower interest rate relative to your credit score and are funded faster.
These loans sometimes have restrictions on how you can spend the money. They may also have higher interest rates and shorter terms, typically one year. SBA microloans can take 2-3 months to process.
If you need a small loan and are part of an underserved or special interest business community, it’s worth exploring microloans.
Business credit cards can be issued by your bank or a credit card company. Business credit cards are different from personal credit cards, typically allowing for larger spending limits and providing more perks. They can be secured or unsecured.
There are numerous options for small business credit cards, and you can get more than one. Most business cards offer quick, easy, and convenient access to funding as well as rewards, cashback schemes, and interest-free terms of up to 90 days. As you pay off the balance, you can build your credit record, which can help you get more significant financing later. You or your employees can use credit cards for ordering supplies and paying business expenses quickly while tracking them and keeping them separate from personal spending.
Small business credit cards can tempt business owners to overspend. They can be liabilities if lost, stolen, or abused by employees, so it is important to have controls and limits in place. Credit cards are not scalable for larger financing needs because of their very high interest rates and spending limits. Additionally, you may experience a negative impact on your credit score if you make late payments or maintain large balances over a long period of time.
Responsible use of small business credit cards can enhance your credit score, keep track of expenses, and improve cash flow while receiving perks, but they are not a scalable long-term financing solution.
If you’re a relative newcomer to the small business financing scene, peer to peer lending (P2P) is filling a financing gap for small business owners. Online P2P marketplaces such as Lending Club and Prosper directly connect borrowers with non-institutional lenders. Your loan application is assessed in the same way as an application to a traditional bank. The P2P loan platform will use a credit reference agency to search for and analyze publicly available information. Combined with your financial history and credit rating, this data determines your lending risk profile and interest rate. If your application is accepted the service will match you with other individuals willing to offer you a peer-to-peer loan.
For many borrowers, P2P lending is a more accessible source of funding. Marketplaces offer both secured and unsecured loans. However, most of the loans in P2P lending are unsecured personal loans. Peer to peer lending for small business could come with lower interest rates because of the greater competition between lenders and lower origination fees.
Some states do not allow P2P lending or they require the companies that provide such services to comply with certain investment regulations. This means that some buyers cannot access these loans. P2P loans are often small and shorter term, so they might not cover all your funding needs. Despite the fact that business owners can get P2P loans for small businesses, these are technically personal loans that come with associated risks. Finally, there’s no opportunity for borrowers and lenders to build a business relationship.
P2P lending may fill a gap for business owners seeking small amounts of capital when existing options are not suitable or available. For non-traditional borrowers who don’t have established businesses or high credit scores, it’s worth investigating P2P loans.
Invoice financing is an income management tool that can make your cash flows more predictable and quicker to materialize. Through invoice financing, a third party provides a loan or a line of credit based on a proportion of your unpaid invoices. The loan amount is usually 80%-90% of the invoices outstanding in return for a fee plus interest. When your customer pays their invoice, you must pay back the loaned amount plus interest. In some cases the lender syncs with your accounts receivable system and collects their fees and interest before forwarding you the balance.
If you have invoices outstanding and need cash to fund operating expenses while you await payment, invoice financing frees up your cash flow that is tied up in receivables. This can be a good financing option for business owners who do not want to pledge personal collateral for a credit facility. Invoice financing is also generally cheaper than a bank loan and easier to obtain, making it an excellent choice for short-term needs. Best of all, invoice financing is fast.
You pay a fee of 1%-3% per month for the convenience and are still responsible for collecting payment from your customers. If they don’t pay, you still owe the amount loaned plus fees and interest.
Invoice financing can be a great option for companies who have a lot of receivables, credit-worthy customers, and need cash immediately for operating expenses or growth opportunities. Explore invoice financing for small business especially if you cannot wait for other forms of financing.
Invoice factoring and invoice financing are similar concepts. In this case, however, you are selling some or all of your company’s unpaid invoices at a discount, typically 10%-20% of the invoice value. Your invoices are then owned by the factoring company, and they are responsible for collecting payments directly from your customers. You will receive the remaining invoice amount, minus a fee, once your customer has paid the full amount.
In addition to the pros listed for invoice financing, particularly if you have longer term outstandings, using invoice factoring will allow you to have more predictable cash flows and reduce your risk. The elimination of debt collection responsibilities can also save your company a lot of time and money.
It takes time to arrange factoring while waiting for the third party to validate invoices. Factoring is not suitable for companies with a few customers only because factoring companies want to spread their customer risk as widely as possible. These companies may also require long contracts of two years or more because of the risks involved. They also charge a higher fee than invoice financing due to the added risk of collecting from your customers. Factoring companies may also be perceived by customers as a sign that your business isn’t doing well, and your customers may resent having to deal with a third party.
Factoring can help your company when it has a lot of longer term outstanding invoices, you don’t have time or resources to chase down payments, and as a result your cash flow is suffering. Be careful to weigh these benefits with the impact on your customer relationships.
Angel investors provide capital for start-ups and small ventures. They are individuals with spare cash who are looking for higher returns than traditional investments would offer, usually 25% or more. Angel investors bridge the gap between small-scale financing provided by family and friends and venture capitalists. An angel investor typically receives a convertible note that has an interest rate, a valuation cap, and a maturity date. Upon a certain date or event, investors can convert their notes into preferred equity shares.
Compared to a business loan, angel investor funding is less formal and more flexible. You won’t have to do a lot of paperwork. These investors can step in and finance companies that banks might find too risky. Funding doesn’t usually require monthly payments, which helps your cash flow. Many angels also provide guidance, support, and networking.
There are online resources to find angel investors, like AngelList and FundersClub, but obtaining angel investment is actually pretty difficult without personal contacts. The informal nature of angel investing can make negotiating terms complicated. Funding amounts are typically smaller than some bank loans, usually below $200,000.
Angel investors receive convertible debt at a premium, and then at the subsequent valuation of your business, they can convert that debt into equity. The more times you raise funds this way, the more equity and control of your company you lose. Angel investors expect companies to grow rapidly within three to five years so they can achieve the high returns they seek, so you will be pressured to do what it takes to continue growing your company.
While angel investors are a less obvious source of funding, it’s worth considering under certain circumstances, especially if your business presents a high risk/reward investment scenario or the opportunity for fast growth. There are many positives, including gaining expertise that can elevate your business and the potential to network to find future investors. However, you’re giving away equity in your company as well as some of your decision-making power.
Partner financing occurs when another company in your industry, such as a supplier or distributor, funds your business growth in exchange for items such as product, distribution rights, proceeds from your company’s sale, or royalties. Partner financing is normally provided in the form of equity investment.
Most times, the company you partner with will be in your industry and can provide resources and expertise. Partner companies are usually larger and have access to a customer base, marketing programs, and other assets that your business can utilize. They also have a vested interest in the success of your business as an equity holder or royalty recipient.
If your business interests and goals are not aligned, partner financing can be challenging to manage. Royalties or distribution deals can be detrimental to your long term performance if not limited. If you or your strategic partner are unable to live up to your obligations, it could be detrimental to your business relationship.
Partnership financing can be fruitful for your small business so long as the deal is structured as a win-win for both parties and your business interests are aligned.
Small business grants are essentially free money. Grants are offered by nonprofit organizations, government agencies, and corporations for many different reasons. Many of them focus on special interests and target groups, such as minorities, veterans, or women. The SBA, for example, grants funding to community organizations to promote entrepreneurship and businesses in certain industries. Grants are great sources of funds for startups in particular.
Free money is the best part. In general, if you qualify for one grant, your business probably qualifies for more. Some grant-giving organizations also offer advice and resources for your business.
Free doesn’t always come easy. You will have to do quite a bit of homework to research grants and their requirements. Grant applications can be very time consuming and because there is so much competition for grants, you may find they are not the best use of your time. Furthermore, most grants take several months to be distributed and require recipients to submit documentation and regular updates on how the funds have been spent and the results achieved.
If you think your business may qualify for a grant, it’s worth putting some time into this funding option, as long as you are realistic about your chances of obtaining a grant and take a long term perspective.
Small businesses can raise money online through crowdfunding by offering equity, rewards, or debt to investors. Many people think of crowdfunding as an option for startups, but established small businesses can raise funds online as well, especially if they manufacture or sell products, have a high growth business that can be easily expanded, or have an innovative technological solution.
Examples of crowdfunding platforms include Kickstarter, Indiegogo, Fundable, and SeedInvest.
Examples of crowdfunding platforms include Kickstarter, Indiegogo, Fundable, and SeedInvest.
Crowdfunding platforms offer low fees, a large audience of potential investors and customers, and allow for a variety of funding campaigns.
Crowdfunding loans for small businesses require a strong promotional strategy, transparency, and possibly giving up some equity in your business. There are many projects and businesses competing on each crowdfunding platform so it can be hard to get noticed. Some platforms can have high fees.
Crowdfunding can be a great option if your small business needs to increase sales quickly, or if you need funding for product line expansion. You have to be organized to promote your business and possibly willing to give up equity.
A significant number of small businesses explore their options with bank banks when they need cash. But without a profitable business with a history and great credit, big banks may not be able to lend you the full amount, when you need it, and on the terms you need to run your business successfully. The good news is that there are a variety of financing options that you can choose from, some of which may be more suitable and easier to access than a traditional big bank loan. It’s worth taking the time to investigate some of these alternatives and identify new potential sources of financing to be better prepared for future financial decisions.
Better yet, take the time to research and establish relationships with banks and lenders that truly understand your business model and goals. There may be a better, faster, and smarter way to finance your small business than by filling out stacks of rigid applications.
For more tips on how to fund and grow your small business, check out the Viably blog.