Small business owners and entrepreneurs never lack good ideas, but they may lack the cash to get those ideas off the ground. Thankfully, there are a number of funding options that can help. The right one depends on your goals, how much money you’re hoping to raise and where you are in the business lifecycle.
To better understand the current landscape and the most viable options available, we turned to small business funding expert Gerri Detweiler, co-author of Finance Your Own Business: Get on the Financing Fast Track.
Small Business Xchange (SBX): What the main funding options for small businesses?
Gerri Detweiler: There are so many options and that can be really confusing for small business owners. Here are the main types:
- Loans. Small businesses can apply for loans from their bank or through online lenders directly. Or they can apply for a loan through the Small Business Administration (SBA). There are also microloans from nonprofit community development financial institutions (CDFIs). Often, these loans have an economic development goal, maybe to create jobs or to make loans to borrowers from underserved populations, like minority-owned businesses, women-owned businesses, or veteran-owned businesses.
- Lines of credit. You can also get a line of credit through your bank, an online lender, or the SBA. These could be just several thousand dollars to a couple million dollars for large, well-established businesses. Loans and lines of credit are the most popular type of financing small businesses pursue, according to the Federal Reserve’s Small Business Credit Survey.
- Credit cards. A business credit card can be a very feasible option, especially for new businesses that might have a hard time getting approved for a line of credit. Approval depends on your own creditworthiness and your own income.
SBX: What are some alternative types of small business funding?
Detweiler: One great option is crowdfunding through a platform like Kickstarter or Indiegogo, which lets you raise money from the public. There two main types: Rewards-based crowdfunding, where businesses give out an early version of the product and equity; or investment crowdfunding, where a business can raise money by offering shares.
Another option is merchant cash advances, which is a type of loan where a lender advances you money based on your past sales. It’s a very short-term loan, but it can be expensive. The interest rate is described as a factor instead of an annual percentage rate (APR). For example, a 1.5 factor would mean that you have to pay back 1.5X the amount of the advance.
SBX: What kind of financing is best for startups?
Detweiler: Startup loans are very hard to get. You can certainly try your bank. There are also SBA loans for startups, but not many SBA loans go to startups. Beyond that, credit cards are very popular. I recommend using a card that offers 0% interest for 12 months, which could help you get things off the ground. And then, there’s crowdfunding.
SBX: What do small businesses need to know about SBA loans?
Detweiler: The Small Business Administration doesn’t make loans directly. It guarantees loans. So you go to a lender that has been approved by the SBA to offer loans (typically banks). SBA loans are very attractive because the interest rates are generally lower than you find at banks. As long as lenders meet the SBA’s requirements and they don’t discriminate on a prohibited basis, they can have their own requirements for the loan. For example, credit. Most SBA guidelines say borrowers should have “acceptable” credit. They don’t state a specific credit score. But lenders might have a minimum credit score.
SBX: How can small business owners prepare a strong loan application for an SBA loan?
Detweiler: For starters, you will need very good credit. For some SBA loans, you will need to make an equity injection, which means that you must make a down payment of 10% or more of the loan amount in your business. And you need a really solid business plan with financial projections that make the lender feel comfortable with you and your business.
Don’t expect the process to be fast and easy. On the other hand, you can expect your SBA lender to guide you through it. They don’t want to spend a lot of time with you and then not make the loan.
SBX: Should small businesses finance their operations with credit cards?
Detweiler: We tend to think of all credit card debt is bad, but in a small business context, credit cards can be essential. However, you don’t want to go into debt for things that aren’t going to move the needle in your business.
If you’re using a credit card for your business, make sure it’s a dedicated credit card. Ideally, it’s a business credit card. Typically, these cards are designed for business purchases and might have better rewards than consumer cards. But even if it’s a personal credit card, make sure it’s a dedicated card that you only use for business, so you’re not mixing business and personal purchases.
Remember, business credit cards aren’t covered by the CARD Act. For example, business credit cards can raise your interest rate if you’re late with a payment right away. You’d have to be 60 days delinquent for a credit card company to raise your interest rate on existing balances with consumer credit cards.