Small Business Financing Options

The first step in funding your venture is understanding the most common small business financing options.

In this guide, we will help you determine if and when you need funding and introduce you to the various types of funding that might be right for your business.

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Determine if You Need Funding

Small businesses require funding for a number of reasons. Startups often need funding to cover their initial expenses until they become profitable. Small businesses also regularly need money to expand, grow, build inventory, and even get through slow seasons.

To determine if and how much funding you need, you will have to rely on careful business forecasting and planning. Thoroughly researched and crafted Income Statements, Cash Flow Statements, and Balance Sheets give you a good idea of if and when you will need money for your businesses.

Many types of business financing will require that you provide a business plan with detailed financial statements and forecasts. To learn more about planning your business, see our free guide on How to Write a Business Plan.

Debt vs. Equity Funding

One decision that you will need to make is deciding on the appropriate mix of debt vs. equity financing.

With debt financing, you borrow from a lender and repay the debt (plus interest and fees) with regular payments. Thus, while maintaining equity in your businesses, you are taking on increased expenses.

With equity financing, you sell a percentage of your business to an investor(s) in exchange for the capital to start or grow your business. Although these funds do not have to be repaid, you are giving up a stake in your business (and its future profits).

Consequently, debt and equity funding both have their benefits along with their drawbacks. Choosing the right mix of funding will rely on your business’s specific needs.

Types of Small Business Financing

Small business financing can be broken down into a few categories that either fall into debt or equity-based financing. The most common types of business funding are:

Self-Funding Your Small Business

The most common funding for small businesses comes from their owners’ personal savings. Self-funding your business may involve personal funds and assets, credit cards, and personal loans.

Funding your business is as easy as putting money from your personal account into your business bank account. However, make sure this money is properly recorded as a loan or equity investment in your company’s accounting records.

Friends and Family Loans

After self-funding, friends and family are typically the second place that startups and small businesses turn for funding.

Friends and family are often your biggest supporters. While they are more likely to offer friendlier terms that don’t rely on collateral and credit reports, it is important to keep it professional.

We recommend reading our Friends and Family Loans guide to learn how to keep your relationships intact when money gets involved.

Small Business Credit Cards

Another important source of funding for startups and small businesses are small business credit cards. There are many different types of small business credit cards, each with its own mix of interest rates, fees, benefits, and rewards.

Take a look at our guide on How to Choose a Small Business Credit Card to find the right small business credit card for your business.

Small Business Loans

Small business loans are another popular form of funding your business. Small business loans allow you to fund your business without giving up equity — an important consideration for founders and business owners.

There are many different types of small business loans available from banks and other lenders, the most common being:

  • Small Business Association (SBA) 7(a) small business loans — These are the most common type of business loans and are backed by the SBA.
  • Working Capital Loans — A working capital loan is a revolving credit line, typically extended through a bank. The funds are made available to a business for practically any business purpose. The borrowing business only pays interest on the money used, not the total borrowed amount.
  • Business Term Loans — A business term loan is the standard traditional loan type in which a business borrows money, usually from a bank. The money is handed over as a lump sum to be repaid over set intervals over a designated period of time.
  • Business Factoring Loans — A business factoring loan means selling your business’s unpaid accounts receivables. You decide which unpaid receivables you want to sell to a factoring company, and once accepted, they will issue you money. The factoring company charges a fee for this and takes the balance of the amount they agree to pay you and the amount of debt owed.
  • Microloans— Business microloans are smaller loans, typically ranging between $5,000 to $50,000. Generally, a small business owner can partner with a nonprofit or government agency to access these loans.
  • Merchant Cash Advance Loans — A merchant cash advance lender extends a loan to a business in exchange for a percentage of future credit card transactions.
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Recommended: Read our review of the Best Small Business Loans to find the best lender and loan for your business needs.

Small Business Grants

Small business grants are free money (i.e., does not have to be repaid) provided by federal and state governments, non-profit organizations, as well as some corporations.

Grants typically provide money for a specific purpose or to a specific demographic. For example, there are a number of small business grants explicitly for women, minorities, immigrants, veterans, and even felons.

Since grants are free money, they are often highly competitive. There is also a significant amount of work that goes into both the application process as well as tracking and reporting what the grant money was used for. However, since your time is the only thing you have to lose, many people find pursuing grants a worthwhile endeavor.

A popular place to begin searching for small business grants is the SBA. The SBA partners with numerous organizations to provide financial assistance for small businesses. In addition to grants for research and development, such as the Small Business Innovation Research program and the Small Business Technology Transfer program, the SBA also supports a number of other programs offering aid to a variety of small businesses.

If you do not find any grants that you qualify for with the SBA, your next stop should be www.grants.gov. The US government’s grant database gives you access to thousands of grants, including hundreds for entrepreneurs and small businesses.

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Recommended: Read our guide to the Best Small Business Grants.

Angel Investors and Venture Capital Investors

If you plan to grow your company exponentially, consider working with professional investors.

Angel and venture capital investors give more than just money to the ventures they support. They can often provide valuable experience and resources to help your new business expand at a rapid pace.

Angel Investors

Angel investors are high net-worth individuals (or groups of individuals) who invest startup capital in entrepreneurial ventures to exchange convertible debt or equity in the venture.

Angel investments are a popular way to raise startup capital that can be leveraged toward the business. Although startups seeking angel investments will need to give up ownership or equity (and even some decision making and control) in their company, angel investors and investor groups may be able to provide valuable guidance, advice, and network connections.

Venture Capital Investors

Venture capital (VC) is a type of private equity in which venture capitalists (both individuals and firms) provide seed, startup, and early-stage capital to ventures with high-growth potential.

Venture capital is another way to raise startup capital that can be leveraged toward the business. Although startups seeking venture capital also need to give up ownership/equity (and even more decision making and control) in their company, venture capitalists are often able to provide valuable guidance, advice, and network connections.

Crowdfunding

Crowdfunding, or raising money for a project or new venture from a large number of people (the crowd), has become an increasingly popular way of raising startup capital. Crowdfunding allows entrepreneurs to bypass traditional sources of funding and go right to their users, supporters, and fans to raise capital for projects and new ventures.

Donation-Based Crowdfunding

Donation-based crowdfunding, a type of backer-funded crowdfunding where the campaign creator(s) ask backers to contribute to a campaign without any type of reward or stake in the venture, is the oldest (and one of the most popular) types of modern-day crowdfunding.

Donation-based crowdfunding is most often associated with charities and social causes. In general, those who support donation-based crowdfunding are primarily motivated by philanthropic principles and find reward in contributing to the social good.

The most popular donation-based crowdfunding platforms include platforms like GoFundMe, Fundly, and RocketHub.

Although the pros of donation-based crowdfunding (like not having to deliver rewards or give up an economic stake in the company) are readily apparent, individuals and for-profit ventures may have difficulty relying on the charity of the crowd to raise startup project capital.

Reward-Based Crowdfunding

The most popular type of crowdfunding for entrepreneurial projects and ventures is reward-based crowdfunding (think Kickstarter & Indiegogo).

In reward-based crowdfunding, campaign supporters are promised a reward for contributing to a project. Most often, rewards include the products or services that the campaign was created to fund.

Crowdfunding raises startup capital while also allowing startups to:

  • Gain exposure
  • Build awareness
  • Validate their ideas

Furthermore, unlike many other types of new venture capital, reward-based crowdfunding does not require startups to incur additional debt or to give up ownership or equity in their venture.

Lending-Based Crowdfunding

Lending-based crowdfunding (aka debt-based crowdfunding or peer-to-peer lending) is a type of investor-funded crowdfunding where campaign creators solicit unsecured loans from the crowd. Asking supporters to invest in projects with the promise of future repayment plus interest.

Examples of popular lending-based crowdfunding platforms include LendingClub, Prosper, Funding Circle, and Kiva.

Compared to other forms of crowdfunding, lending-based crowdfunding does not require giving up any equity in the venture, nor does it require campaigns to offer rewards to supporters. On the other hand, unlike backer-based crowdfunding models, the capital raised through lending-based crowdfunding has to be paid back to the investors in your campaign.

Equity Crowdfunding

In equity crowdfunding, entrepreneurs offer equity in their ventures in exchange for their campaign supporter’s investment.

Equity Crowdfunding provides the potential to combine some of the benefits of crowdfunding with a funding structure similar to traditional equity funding options.

Examples of equity crowdfunding platforms include AngelList, CircleUp, Fundable, and Crowdfunder.

Basics of Business Finance

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