One of the biggest roadblocks in the way of your dream to start a business is finding financing. Afterall, you might need to purchase a new computer, hire someone to build your app, or need new tools just to get started.
The two most common ways to finance your business is through debt financing or equity financing, but within those two categories are a myriad of options that can quickly become overwhelming.
Fret not – below is a quick overview of some of the best ways you can find money to finance your new business.
The most common ways entrepreneurs find cash for their new businesses is through debt financing. Debt financing is when you borrow money from a lender and repay the loan with interest over a short or long period of time.
Small Business Administration Loans (the SBA is a government agency)
The two most common SBA loans are the 7(a) General Small Business Loan and the 8(a) Business Development Program. Both loans are government loans and are only available to businesses and not individuals.
The 7a loan has a negotiable interest rate and can be used to start a new business or to help finance an already existing business.
The 8a loan is a unique loan in that its sole purpose is to help propel small businesses majority owned (at least 51 percent) by people from disadvantaged socioeconomic backgrounds. However, 8a loans must demonstrate future potential of success to qualify.
Banks offer loans to small businesses, usually at a lower interest rate than SBA loans, but have a longer lead time and typically require an A credit rating.
Microloans are small loans up to $50,000 provided by local intermediary lenders (who receive funding from the SBA) and have to be repaid within 6 years.
If you don’t have credit built up, a good way to start building credit is by getting a credit card. You can bootstrap your business using a credit card, but be mindful of its interest rate as they’re often two to three times higher than a private or public loan.
If you’re a veteran, you can certify your small business as veteran-owned and qualify for government contracts, as well as have certain 7a loan fees waived. Fun fact: 1 in 10 small businesses in the US are veteran owned!
The SBA and other philanthropic organizations offer grants (funds that don’t need to be repaid) to small businesses. Grants typically have stringent and specific qualifications because they’re funded through taxes. One downside to SBA grants is that you cannot qualify for them if you are starting a new business.
The second most common way to finance a small business is through equity funding. Equity funding is when you raise money from investors (it could be people you know) in exchange for part ownership of the business. Unlike debt financing, equity financing doesn’t require paying back a loan in a given period of time.
Venture capital is when a pool of cash is raised from various sources, usually professionally managed through a fund, in exchange for shares of your company. One of the main sources to raise venture capital are through Small Business Investment Companies (SBIC’s) who are partially funded (but not owned) by the government. SBIC specialize in certain industries and are professionally managed investment funds.
Venture capital is typically harder to find than debt financing and requires you to give up shares of your business, which enables investors to make controlling decisions on the way the business is run.
Angel investors are high-net worth individuals who are often experienced in the business sector they’re investing in. Unlike venture capitalists who typically want to see that your business is making money, angel investors want to get in on your business early, but usually require more equity and expect higher returns than a venture capitalist due to the risk involved. Angel investors want to get in on your business early and provide advice along the way to ensure your business’s (and their investment’s) success.
If you have a 401k or other retirement account with a sufficient amount invested, you can use it to bootstrap your business without paying the early retirement tax penalty. This method of financing is called ROBS or Rollovers as a Business Startup because you rollover your retirement fund into the capital needed for your business. ROBS are usually done by financial firms and can cost upwards of $5,000 to be set-up properly.
Crowdfunding is a method of raising capital that seeks small donations or purchases from a large amount of people to meet your funding goals. Crowdfunding is a great way to market your small business while raising money. However, due to its public nature, it puts the reputation of you and your business on the line. Crowdfunders generally expect results quicker than other lenders.
Reverse Mortgages and Home Equity Loans
If you’re over the age of 62, a reverse mortgage is a great way to start your small business. A reverse mortgage converts the equity from your house into cash. This method doesn’t need to be paid back to the bank in a given period of time, but must be paid back eventually, even upon death.
Home Equity Line of Credit (HELOC) loans convert the equity of your house into credit. HELOC loans don’t have age requirements to qualify and typically have low interest rates. The downside to a HELOC loan is it essentially serves as a second mortgage; it must be paid back monthly or the bank will put a lien on your home, giving them the right to own it.
Peer to Peer Lending
Peer to Peer Lending (P2P) is an online financing method in which you post about your business on websites like Prosper or Lending Club and negotiate with individual lenders to finance your business.
Family & Friends
One of the best but perhaps riskiest ways of funding your business is by raising money through family and friends. Your friends and family won’t be asking about your credit or put you through the bureaucratic lending process like banks will. Keep in mind though that raising money from family and friends requires you to really be on top of paying them back or jeopardize your most important relationships.
By Juneau Dahl • April 22, 2021
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