Launching a small business requires an enormous amount of work and planning, and it also requires faith in your ability to make a successful enterprise. One of the biggest challenges for small businesses is financing.
Where do you get the money you need to pay overhead while pursuing your growth goals?
At CMP, small business owners are valued clients. We love working with entrepreneurs and business owners to help them manage their finances. This includes assisting them in evaluating their growth financing options and helping them decide where and how to obtain funding for business growth. With that in mind, here’s our overview of small business financing, including a breakdown of each option.
Small Business Financing Overview
Small business financing can take many forms, each with pros and cons. Some forms of financing require collateral to secure a loan, while others may be unsecured. It is typical for unsecured loan amounts to be smaller than secured loan amounts.
The type of financing you choose for your small business will depend upon your financial needs, the status of your company, and the reason you need the money. For example, you might choose a different financing option to meet daily expenses than pursuing a long-term growth or expansion goal.
Small business financing may include short-term or long-term lending, grants, lines of credit, and even business credit cards. You may want to consider hiring an outsourced CFO to help you evaluate your options and obtain the financing you need.
What to Consider Before Seeking Small Business Financing
There are multiple factors to consider before you seek small business financing of any type. Here are some of the most important considerations to keep in mind.
- What types of financing are available to you? A new business might not qualify for a business line of credit but could seek investors or an SBA loan.
- Do you have a business plan? A detailed business plan is essential for businesses of every size and is critical for new businesses to obtain financing.
- What is your credit score? You may need to meet a threshold for your business credit or—in situations where you are asked to sign a personal guarantee—your personal credit to qualify for financing.
- Do you have enough revenue to qualify? For many of the financing options we discuss, the most important qualification is having sufficient income to repay your debt.
- Is your paperwork in order? Each form of financing we’ll discuss in the next section has documentation requirements. If you don’t have an up-to-date balance sheet or AR listing, you’ll need to get those things in order.
- Have you read the fine print? Before you sign on the dotted line, you should be sure to read through your entire lending or financing agreement. We suggest working with a qualified CPA to ensure you understand what you’re signing.
Keep these things in mind as you prepare to apply for small business financing.
Small Business Financing Options
There are many financing options available for small businesses, including some that are ideal for start-ups. Here are 11 types of financing to consider, with pros and cons for each to help you evaluate your options.
Traditional Bank Loans
Traditional bank loans are available from credit unions and banks. They may be short-term or long-term loans. Short-term loans typically have terms between one and three years, while long-term loans may have terms as long as five years.
Most banks require collateral for loans, but it may be possible to get an unsecured loan as well. If you get an unsecured loan, you should expect a rigorous underwriting process with added scrutiny of your business finances and, potentially, your personal credit.
- Fixed and predictable payments
- Long and short-term loan options
- Secured and unsecured loans are available
- Strict underwriting processes that can take weeks
- Possible scrutiny of your personal finances
- Collateral is often required
SBA loans are available through the Small Business Administration, which provides small business loans to qualified organizations. There are several loan programs to consider. Here are three of the most popular.
- SBA 7(a) Loan is available in amounts from $5,000 up to $5 million. Unsecured loans are available for up to $25,000; larger loans will require collateral.
- SBA 504 Loan is a project funding loan with a rigorous underwriting process that requires business owners to document the project being funded. You’ll need an average net income of $5 million or lower to qualify.
- SBA Express Loan has a quick approval time—in most cases, your application will be reviewed within 36 hours, but it can take up to 30 days to get access to loan funds. This loan is available in amounts up to $350,000.
- Large and small loans are available
- Interest rates are capped
- Broad eligibility requirements
- Businesses that can’t qualify for bank loans can get SBA loans
- Collateral may be required
- You may be on the hook personally if your business fails
- Can take 30 days or more to get access to funds
Debt financing provides cash flow by selling bills, bonds, or notes to investors. Each fixed-cost asset sold must be repaid at a future date.
In most cases, investors also receive annual “coupon payments,” which take the place of the interest charged with other forms of financing.
- You won’t give up control of your company
- You’ll get immediate access to the capital you need
- The interest on your debt is tax deductible
- You must repay your debt regardless of your cash flow
- You’ll need to make annual interest/coupon payments
- Can be risky for companies with inconsistent cash flow
Business Line of Credit
Business lines of credit (LOC) provide rolling credit for businesses to pursue their growth goals. Amounts may range from a few thousand dollars to a million dollars or more and you can expect the approval process to take several days to a week.
With a business LOC, you pay only for what you withdraw, and you can repay and reborrow as many times as you want within the term.
- They can even out your cash flow
- You can pursue opportunities as they arise
- You pay only for what you borrow
- Interest rates tend to be higher than bank loan rates
- The application process can be time-consuming
- You may be tempted to overspend
Online loans are typically offered by non-bank lenders and may have more flexible underwriting requirements and fast turnaround times. They are often available to start-ups and struggling businesses that might not qualify for a bank loan.
Online business financing can take many forms, including short-term and long-term loans and business lines of credit.
- Streamlined application process
- Flexible underwriting
- Quick access to money
- Rates are higher than bank loans
- Limited service or person-to-person interaction
- Risk of fraud
Business Credit Cards
Business credit cards provide enterprises with an easy way to pay for ongoing expenses and overhead. Once you’re approved for a card, you can use it to pay for supplies, materials, entertainment, and other expenses.
The biggest risk associated with business credit cards is overextending yourself and winding up with more debt than you can handle.
- Easy to obtain
- Provides credit to purchase materials and supplies
- Convenient to use
- Interest rates are likely to be high when compared to bank loans or business LOCs.
- Charging too much may lead to unmanageable debt that will negatively impact your business.
Merchant Cash Advance
A merchant cash advance allows businesses to get an immediate advance on credit card payments they receive. Instead of waiting several days for the credit card issuer to transfer funds, they can submit receipts to a merchant cash advance company.
The option of a merchant cash advance is most likely to be appealing to retailers and restaurants which have a high volume of credit card transactions.
- You can qualify even with less-than-perfect credit
- You get quick access to cash to pay daily expenses
- It doesn’t add to your debt
- It’s one of the most expensive forms of small business financing
- Your MCA lender may deduct money for repayment daily
- The MCA industry is still unregulated
Vendor financing involves a lender loaning money to a business owner with the understanding that the borrowed funds will be used to purchase the vendor’s services or products. While the vendor assumes some risk, engaging in vendor financing may give them an edge over their competitors.
Vendor financing allows the borrower to delay pursuing bank financing by providing borrowers with the money they need to make necessary purchases.
- Solidify your relationship with your vendors
- Makes it possible to delay bank financing
- Easy to qualify for
- You’ll need to pay your vendor interest on what you borrow
- Failure to repay can sour your relationships with vendors
Invoice factoring is a form of short-term financing that provides businesses with advances against their accounts receivable. In some cases, money may be available in less than 24 hours after submitting invoices for factoring.
The underwriting and approval process for factoring tends to be less rigorous than it would be for a bank loan and may even be accessible to start-up businesses, provided they have orders in the pipeline and a solid business plan.
- Rapid access to financing
- Available to start-ups and established businesses
- Provides short-term cash flow
- Rates are significantly higher than other forms of financing
- Some factoring companies will chargeback invoices if they are not paid on time
- Vendors pay the factoring company directly, and some may be uncomfortable with the arrangement.
Investor equity is a form of financing obtained when you sell equity in your company to an investor in return for their investment. The investor’s equity gives them a say in how your company runs.
Equity investors may provide small or large amounts of money depending on their interest in the company and how much money the business needs.
- There are no loan repayments to make
- You can use the financing obtained to improve your credit
- Your equity investors may have valuable insights and ideas to help your business grow
- You won’t have full control over your company
- You’ll need to share your profits with equity investors
- There’s a potential for conflict if there are disagreements about how to run the business
A business grant is a financial award given to a business in need. Unlike a loan, it doesn’t need to be repaid, and there is no interest.
Because grants do not need to be repaid, they can help you grow your business more quickly than you could with a bank loan or a line of credit.
- Money is free and does not need to be repaid
- Qualifying for one grant makes it easy to get another
- Can increase your company’s visibility and credibility
- The process of applying for a business grant can be time-consuming
- Grants may come with a lot of strings attached
- You may need to reapply to renew your grant
Choosing the Best Small Business Financing for Your Needs
Business financing comes in many forms and can be obtained from many sources. You’ll need to sort through your options and evaluate each before you begin the application process.