How Do Small Businesses Get Funding? Your Questions Answered

Growing, managing, and evolving your business has a learning curve. Funding your small business is no different.

Finding the right funding program begins with understanding what’s out there. Next, it’s all about research. The most appropriate business funding solution will vary depending on your specific circumstances. In this article, we run you through some frequently asked questions about small business funding, including when you should apply, how much to ask for, and a few different options available to you.

When Should I Start Looking for Small Business Funding?

Generally speaking, it should be pretty clear when your company needs a cash injection. Usually, you’ll find yourself having issues with capacity in financial or human resources. Therefore, you’ll want to think about looking for funding when you need to:

• Hire new employees
• Open a new location
• Buy more inventory
• Buy new equipment
• Get working capital for everyday costs like rent and payroll
• Refinance old debt that’s racking up interest

How Much Should I Ask for?

When applying for a loan, it can be tempting to ask for as much as possible. It’s crucial to remember there’s no such thing as free money (unless, of course, it’s a gift). Therefore, you must assess what you can afford. On the flip side, make sure you don’t ask for too little. You want your funding to have mileage. The best way to figure out how much to apply for is to ask yourself three key questions:

• What do I want to use the money for? Here, it’s important to be specific: How many employees do you want to hire? How much will renovating a new location actually cost? How much do you need to spend on that marketing campaign ?

• What will the return on this activity be? For instance, how many more orders will you be able to meet with these two new employees?

• What business expenses do I already have? It’s critical to include in this calculation any existing interest on the debt.

The best way to forecast the amount you need is to constantly monitor your business performance. Make quarterly projections yourself or with the help of an accountant, estimating revenue and profit over a given timeframe. With these estimates, you can calculate how much funding you need and what you can afford.

What Type of Business Funding Should I Go For?

In essence, there are two main types of business funding: debt financing and equity financing.

Debt financing is where you fund your business by borrowing money. In this scenario, a lender — like a bank — gives you a loan. You pay them back over time with interest. Debt financing is the most straightforward option for most small businesses.

In contrast, equity financing is when you raise money by selling a portion of your company to an investor. These investors could be venture capitalists, angel investors, or even business partners. Equity financing has its benefits, like mentorship and experience, but you have to be prepared for a long-term relationship with the investor.

There are big barriers to small business owners accessing venture capital. Generally, these investors tend only to do multimillion-dollar deals with companies set for exponential growth. If your company is a tech startup with huge scaling potential, knock yourself out. For most small business owners, keeping control of your enterprise and opting for debt financing is likely to be more practical.

How Do I Know Which Type of Funding Is Right for Me?

If you’re trying to decide whether to go for debt financing or equity financing, you need to consider the following factors:

• Your sector: Some industries fare better with equity financing than others. For instance, tech and financial companies often attract investors because they promise high turnover on short timescales with limited resources. People active in these industries are also more likely to have links to venture capital or angel investors.

• How much money you need: Venture capitalists generally deal in millions, not thousands. If you’re an established business owner who needs a little boost for everyday costs, debt financing is a more practical option.

• Your timescale: If you need funding fast, go for debt financing. While bank loans can have long lead times, alternative lenders can get you funding in just 24 hours.

• Control: This is crucial if you’re exploring equity financing. You need to think about how much control you’re willing to cede for financial support. Depending on the portion of the company the investor owns, they can significantly influence day-to-day decisions.

What Are My Options for Debt Financing?

If you’re a small business owner, you’ll likely be exploring debt financing. However, there are many different types of debt financing out there. Here are a few of the most salient options:

Long-Term Loans

A traditional long-term loan is probably the kind of debt financing you’re most familiar with. Available from banks, long-term loans are best suited to owners of established businesses who want financing over a long period of time, typically more than two years. This funding will have predictable monthly repayments over a fixed term with a fixed interest rate. These loans are useful for expansion, working capital, and refinancing. Because the rates tend to be relatively low, you need to prove you have a strong credit history and robust business performance to qualify.

SBA Loans

The Small Business Administration (SBA) is a US federal agency dedicated to helping entrepreneurs grow their businesses. Long-term loans from the SBA are an extremely desirable type of business funding because they are so affordable. However, it’s important to understand that the SBA itself doesn’t grant loans; it guarantees debt on behalf of other lenders. This means the agency incentivizes lenders to approve funding by mitigating the risk. There are three main types of SBA-backed loans:

• 7(a) loans: The 7(a) loan program is the most common program, offering up to $5 million for working capital, equipment financing, real estate purchases, startup costs, and even debt refinancing.

•Microloans: Microloans are loans under $50,000 for entrepreneurs who need a little boost to take their business to the next level. Small businesses struggle to get access to smaller loans from banks because these loan amounts aren’t that profitable, so the SBA meets this need.

• CDC/504 loans: The CDC/504 loan program  is for financing real estate or other major fixed assets like large equipment or land redevelopment.

Despite the affordability of these loans, you will be subject to the terms of individual SBA-approved lenders. This includes their interest rates and repayment terms, which are set within SBA boundaries. Usually, you’ll need an exemplary credit file, consistent revenue, and a compelling business plan to get one of these loans.

Short-Term Loans

Generally speaking, the faster you need funding, the more expensive the loan. However, a short-term loan can offer a balance between affordability and speed.

Short-term loans essentially work like expedited versions of their long-term cousins. You’ll receive a lump sum, which you’ll pay back for a fixed term with fixed interest. Usually, a short-term loan will be smaller but have a higher interest rate. Despite the cost, short-term loans tend to be more accessible than their long-term counterparts.

Business Line of Credit

A business line of credit essentially functions like a credit card, making it extremely versatile. The lender will grant you a certain amount of capital you can use when you see fit, and you’ll only pay interest on what you borrow. In addition, when you pay back the funds, you’ll have access to the cash again, which is why business lines of credit are also known as “revolving” or “rotating” credit lines.

A business line of credit is useful for companies that experience revenue fluctuations. Generally, the lender will allow you to use the money how you want, including for working capital, inventory purchases, or refinancing. However, a line of credit comes with a catch: You need to have a truly excellent credit history. Business lines of credit can be even more difficult to qualify for than bank loans.

Equipment Financing

Equipment leases or loans offer a streamlined way to get funding for business infrastructure like computers, machinery, or vehicles. These funding programs are asset-based, which means lenders collateralize the funding with the equipment. Whereas other types of funding depend more on your credit history and financials, equipment financing is more like car leasing. Since the purchase backs the funds, the lender is more likely to approve financing even if your credit history isn’t exactly glittering.

However, it is important to understand the difference between equipment leases and equipment loans. With a lease, you are effectively renting the equipment from the lender. At the end of the repayment term, you may have the option to purchase the equipment outright. In contrast, an equipment loan is more like a traditional loan, with a payment schedule and interest.

Invoice Financing

If delayed payments from clients are causing cash flow issues, invoice financing can help get you back on track. Generally, invoice financing is most suitable for B2B companies with capital tied up in unpaid invoices. Most invoice financing operates by offering a cash advance of about 85 percent of an invoice’s value. Then, when your client pays the invoice, you’ll get the additional 15 percent, minus a fee. The handy thing about invoice financing is that the lender tends to be uninterested in your credit history. They care more about your clients’ repayment patterns.

The Bottom Line on Small Business Funding

There’s no hard-and-fast funding solution for every business. Finding the right program is a bit like learning how to grow your company: It often happens through trial and error.

On the bright side, there’s a world of options out there to help you grow your business. With proper preparation and thorough research, you can make a choice that meets your business needs.

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