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Small Business Start-Up Financing Options
Every year, choices for business financing are more plentiful: small banks, Internet banks, crowdfunding, grants and creative investment are just a few of the methods growing rapidly. However, running concurrently with this availability is a set of legal risks that also grows each year. Small businesses have less protection than corporations in banking and loan fulfillment areas, in general, but carry liability in every job they do or product they sell. This is especially true for sole proprietors, who usually risk home and family finances when starting or expanding their ventures.
Whether you have a great business idea or are planning a new segment for an old business, funding is probably your biggest challenge. A complete, sound business plan in hand, you enter the financial fray that has exploded with choices in this digital century.
We will look at traditional and emerging methods for financing with an eye toward the “risk vs. reward” dilemma that small enterprises always face. 1 Entrepreneurs know it well, whether they have begun one or a dozen businesses.
With friends like these …
First-time business owners often approach friends and relatives about funding a business idea. They might ask for outright gifts or offer some part of profits or percentage of the company in return. New owners might offer partnerships in return for investment. These opportunities are vital to new business development provided the legal aspects are completely worked out in writing.
Gifts are a great way to begin a venture, but any money given must have absolutely no expectations attached by the giver. A gift must be specifically attested in writing. Remind givers that this protects everyone involved (in some cases gifts are deductible).
Investments are contracts between the financial parties. Friends and relatives are some of the best initial investors, but any contract must stipulate what happens if a business fails. The elephant or the 500-pound gorilla in the room is this fact: most ventures fail.
Create a payback schedule and exit strategy as outlined in your business plan. Address the specific investor with each consequence in the event of failure.
Your wish is granted
Grants from government entities could be a big part of your financing strategy. State and local governments have a wide variety of grant programs for new businesses, but restrictions and requirements are rigid. However, many communities have in place
revitalization plans that include generous grants for businesses that open within certain geographic locations.
If your enterprise has a retail or office-space component, these “revitalizing Main Street” grants might work. They have particular interest in micro businesses and micro loans, generally under $5,000. These loans allow individuals to get the basic funds to start an
idea on its way. According to statistics 2 , seventy-five percent of small businesses are sole proprietors and fifty two percent are home-based enterprises. Local grants are ideal for these individuals. Do your homework by finding out all the detailed requirements for getting a grant; grantors look dimly on applications that do not fulfill their requirements.
The Small Business Administration and National Association for the Self- Employed (NASE) are the best starting points for information about grants. There are many types and you can get help finding exactly what is available for your business start-up.
Lend a hand
Business lending is one of the leading financial sectors in the United States. Every business needs capital on hand or promised. Developing a business generally means developing lending relationships with banks and others. Aside from personal loans from
friends and relatives, commercial lending is a mainstay for American entrepreneurs.
Being a small business owner can be extremely fulfilling and very worrisome, and for the same reason: money. While owners love the freedom of being their own boss, most find that a lender or two are bosses as well. Don’t let this become an impediment. Look at lenders as partners in helping your business succeed; whether a big bank or small loan company, you are helping their business succeed, too.
After getting your business plan in the best possible shape, seek lenders who advertise expertise in your business and local areas. Check credentials and reviews of local lenders. Check with friends who have their own businesses or deal with finances regularly. Accountants and managers at local businesses are probably willing to help. This traditional lending arrangement is an alternative to using your own credit cards and finding friends or relatives who can help.
The Small Business Administration (SBA) offers government backing to lenders who make small business loans, so the risk to the lender is less severe. The SBA does not loan money directly. Like NASE, the SBA offers guidelines for lending, business plans,
insurance advice and more.
A less traditional but powerful form of funding is venture capital funding. Venture capitalist companies generally offer equity funding with fewer restrictions, accepting more risk than traditional banks. Venture capitalists usually invest in ideas that they believe have potential for fast or large profit.
Join the crowd
A new frontier has opened in fund sourcing. Crowdfunding, or crowdsourcing, is all the rage for financing small ventures. On its face, the situation seems ideal: a lot of people you don’t know (and some you probably know) send small donations in support of a great idea for a business. In its simplest form, the crowd out there helps the little guy with very little risk to either. This atypical form of capitalization has grown rapidly for the last decade, as social media has grown exponentially.
This explosion offers a platform for funding everything from injured persons to helping with natural disasters. Entrepreneurs quickly began describing their ideas and asking for funds to get started. The crowdfund is usually built around a unique product or service, but also could fund ventures that have a strong local appeal. Unique restaurants, high tech service and repair, and health/fitness operations are a few of the popular ventures recently funded on www.indiegogo.com. 3
One downside to crowdfunding makes it a less obvious choice for many people: Crowds are unlikely to fund businesses that are not new and exciting. If you are starting a house cleaning business or lawn service, you are less likely to generate a crowdfund of any size. For these types of businesses, as well as franchise owners and operators, other financing as discussed above is usually more appropriate.
There are exceptions. An entrepreneur starting a standard business model but locating in an abandoned property might find that local crowdfunding works because the business has potential to upgrade the area.
Let’s get personal
Finally, we look at some personal financing options that could be ideal for sole proprietors in certain situations 4:
- Use a 401k for start-up funds. If you have battled in the corporate world and are now looking to go on your own, you might have a substantial 401k retirement plan that you can borrow against. The plusses are that the funds have been saved and you will be
paying yourself back rather than a lender. However, it removes some of your retirement funds which otherwise would be getting interest.
- Get a home equity line of credit. These funds are spent as you need them and paid back as a periodic loan. The funds are readily available but are a loan against your property.
- Apply for a personal loan. We end with perhaps the least palatable option for new business owners. A personal bank loan generally has higher interest rates, but you might need little or no collateral depending on your personal credit score.