As a small business owner, you’re charged with the often daunting task of finding enough money to operate and grow your business. There are a number of financing options out there. It’s important to acquaint yourself with all of them so you can determine which best suits your needs and how to go about cinching the deal. These are the most common types of small business financing.
- Angel investors and venture capitalists: Angel investors can be a good source of funding for new businesses. They’re often willing to take on more risk than banks and they tend to invest for longer periods of time than other investors — up to five years or more. However, they’ll generally invest a maximum of $1 million.
Venture capitalists usually invest more, but they have tougher investment criteria and look for high-growth businesses that will provide them with the greatest profit potential. They’re typically looking to cash out in three to five years. So most aren’t interested in very young businesses. Moreover, they almost invariably want a piece of your company and a seat on the board of directors, which can diminish the level of control you have over your business.
- Commercial bank loans: These loans are often preferable because they don’t require you to surrender any equity or company control. However, repaying them can be a strain on younger companies with limited cash flow. Many new companies won’t qualify because they lack an operating history and substantial collateral. Businesses seeking $100,000 or less, though, may qualify for unsecured loans based upon their owner’s personal credit history or personal assets.
- Small Business Administration loans: SBA loan guarantees can make all the difference in whether you get a bank loan. The federal agency doesn’t provide funding but typically guarantees 75 percent of individual loans made by private lenders — up to $750,000. To be eligible, businesses need to demonstrate an inability to qualify for conventional financing with reasonable repayment terms. Business owners must personally guarantee SBA loans and show that they have enough cash flow to repay them.
- Home-equity loans: These can be an attractive alternative to other types of loans because they usually offer the lowest interest rates available. However, you must carefully consider all the ramifications of risking your home to fund your business.
The most important criteria for securing the financing your business needs are a good personal credit history, business history, and a thorough business plan that demonstrates the feasibility of your operating model. In short, a good business plan will provide enough detail to answer any questions a lender might ask.
When creating your business plan, you must state the amount of money you’re looking for and specifically and accurately explain what you intend to do with the money. Be prepared to offer details on how you’ll use every dollar you’re requesting. Are you looking to fund operations, including new employees and marketing? Or maybe assets, including equipment and real estate? Or are you looking to pay off business debts?
Next state when you’ll repay the loan. Explain in detail how the loan will effectively and efficiently grow your business. You must be able to convince the lender — through financial statements and cash flow projections — that you’ll be able to repay the loan based on an increase in your profitability.
Finally, address what you’ll do if you don’t get the loan. Lenders want to see persistence and a deep commitment to your venture. Let them know that you plan to approach as many lenders as necessary to secure the funding you need to grow your business.
Susan Konig is a freelance writer in New York. She has been writing about finance for 15 years, for publications including Crain’s New York Business, The New York Times, and Registered Representative, a national publication for financial advisors.