Financing options for your new business
Learn about the financing options that can help make your dream of owning a business a reality.
The entrepreneurial bug has bitten and you have your business structure, market niche and business plan in place. Now, how will you finance your business?
Start-up financing options
According to a 2014 Intuit survey, 64 percent of small business owners started their businesses with less than $10,000 and costs can be significantly less for home-based sole proprietorships. Here are three financing options to consider in getting your new business off the ground:
Business Credit Cards
The United States Small Business Administration estimates that 65 percent of small businesses regularly use business credit cards to finance their businesses. Remember that unless your business is incorporated, you may risk your personal credit rating and ability to borrow since you are the guarantor of all your debts. As with personal credit cards, it’s important to shop around to find a card with favorable terms. Evaluate costs and fees, annual percentage rate of interest and credit limits as well as the perks, rewards, and business spending reports that business credit cards often provide.
Borrowing From Friends and Family
The Pioneer Institute found that loans from friends and relatives were another common financing techniques used by startups with less than five employees. While it may be a quicker way to access cash, it’s important to take a professional approach when asking those close to you to support your business goals. Be realistic in the amounts you request and remember that relationships may suffer if you are not able to pay back what you borrowed. Because this is a business arrangement, document your agreement in writing to help avoid emotional and legal issues in the future.
Crowdfunding is an increasing popular way of raising funds online. It’s a collective cooperation of people who network and pool their money and resources together to support the initiatives of others. Experts recommend starting your crowdfunding campaign six months before you intend to launch your business. Research similar projects and set your funding goals as low as possible because platforms such as Kickstarter only funds projects when the goal is reached. Make sure you reward your donors with discounts on your product or service if your campaign is successful.
Traditional Financing to Grow Your Business
Once a business has been established for at least two years, more financing options become available through traditional bank sources. In evaluating the creditworthiness of a business, banks are looking for companies that are stable or trending upward. A diverse client base – one that does not depend on just one or two customers – is another indicator of the viability of a young business.
While the information required to acquire bank financing will vary based upon the specific industry of the applicant as well as the particular product he or she is applying for, in general, business owners will need to provide two years of business and personal income tax returns. Additionally, banks will typically want to see balance sheets and income statements from the most recent quarter, recurring and variable expenses and forecasts of sales and cash flow.
To provide a snapshot of a business owner’s personal financial picture, applicants will also be asked to provide information about their personal debt and assets, including the value of their retirement accounts and the value of their homes as compared to their mortgage amounts.
Sourcing Working Capital for Short-term Needs
Bank financing options can be tailored to the needs of a young business. For example, a working capital line of credit can be an effective tool to bridge the gap between the time a business bills a client for services performed and the time the payment is actually received. While businesses that are cash-based or paid immediately by credit card will have little use for a line of credit, manufacturing or service-based businesses have a significant need since they typically have a window of 30 to 60 days or more before payment is received for services rendered. The line of credit can provide cash flow to pay rent, employees or suppliers during that period. In evaluating an application for a line of credit, banks may want to review a business’ accounts receivable and accounts payable aging report to better determine who the business’ customers are, who owes them money as well as who the business owes and how long the debt has been outstanding.
Equipment Loans and Mortgages
For business owners looking to finance equipment purchases, a term loan can be a good option. Similar to a car loan, a term loan allows business owners to make payments for five years. For new equipment, entrepreneurs need to budget for a 10 percent down payment while a 20 percent down payment is required for used equipment.
To own, rather than lease, space for a business, owners can use a traditional mortgage or work with their banker to secure a government subsidized loan, like those provided by the SBA 504 program. This program, which can be used to provide financing for major fixed assets such as equipment or real estate, is a win-win for both the business owner and the bank. With the government as a lending partner, the loan is less risky for the bank and the business owner reaps the benefit of having to put less money down at the onset of the loan.
Think Long-term When making a Financial Commitment
While a number of financing options are available to entrepreneurs, it’s important to take the long view before deciding to take the plunge on expansion goals. While it’s understandable that young companies are eager to grow, if that growth is tied to a single client relationship which ends unexpectedly, the entrepreneur might be placing his or her company in jeopardy since loan payments on new equipment or a mortgage will still be due even if revenue drops significantly. Entrepreneurs should also consider the loss of financial flexibility with a mortgage rather than a lease arrangement, as well as the risks a potential economic downturn may have on future expansion plans. But, with a thoughtful plan and a banking partner’s guidance, financing options are available to help make an entrepreneur’s dreams of a growing business a reality.
For more information on financing a business, visit the U.S. Small Business Administration website.