Business Funding for Startups
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Many startups need a considerable upfront investment of time and money before they start bringing in significant revenues, which means they often need some external financing to sustain them until they can get off the ground.
Unfortunately, investing in any new business is risky, and investing in a startup can be even more so since they often take new approaches to big problems and have aggressive scaling goals.
As a result, securing business funding for startups is a significant challenge. Here are some of the financing types you might consider and what you should know before pursuing them.
Business Funding Options for Startups
Thanks to the spread of online lenders and fintech companies, there are countless financing products today. Not all of them are suitable for startups, though, and choosing the wrong financing method can cripple your company’s growth.
Here’s an overview of some of the best business funding options for startups to help you determine which might be right for you.
Business Loan
Business loans come in different variations, but they generally follow a standard installment debt pattern. Upon approval, you receive a lump sum, then begin fixed payments of principal and interest over a finite repayment term.
You can apply for a business loan with your personal credit, but it’s a good idea to build business credit as well. Separating yourself from your business can help you limit your personal liability for business debts.
To qualify for a startup business loan, you’ll need to meet a lender’s eligibility requirements, which may include:
- Minimum time in business
- Specific ownership characteristics
- Minimum personal or business credit scores
- Industry or location limitations
- Minimum annual revenues
The qualification requirements can vary significantly between lenders as can the loan terms. In general, the more rigorous the eligibility requirements, the better the business loan.
Many consider SBA loan programs the best option due to their high principal balances, low-interest rates, and lengthy repayment terms.
Personal Loan
Just because you’re looking to finance a business doesn’t mean you can’t tap into your personal credit to kickstart your operations. Personal loans are among the most versatile forms of financing, and you can use them to fund your startup.
Personal loans tend to work best when you meet the following criteria:
- Need a lump sum: Personal loans are a type of installment debt, so they won’t help if you’re looking for a revolving account.
- Can’t qualify for a business loan: Only consider a personal loan if you can’t get a business loan. They’re more expensive, and you’ll always be personally liable.
- Have good personal credit: Personal loans can become expensive if you have bad credit. Try to avoid them if you can’t qualify for the lowest interest rate options.
Before you take out a personal loan for startup funding, make sure your lender has no objections against it. They’re usually flexible, but some have restrictions on how you spend your proceeds.
Business Credit Card
While they won’t solve any long-term financing needs, business credit cards can be valuable to just about any company, including startups.
For example, they can:
- Separate your personal and business finances
- Help build business credit so you can qualify for other business financing
- Cover expenses during short periods when cash flows are limited
- Provide discounts and bonuses with cashback rewards
Business credit cards tend to have higher credit limits than personal cards, so you can use the credit line for more than you might think.
That said, they’re still not great for financing significant purchases. If you carry a balance past their grace period and accrue interest charges, it’ll be expensive. Their interest rates are higher than a business loan.
You can qualify for a business credit card with your personal credit scores, but it’s best to switch over to your business credit scores as soon as you can. It’ll help separate you from your business, which can mitigate your personal liability for business debts.
Business Lines of Credit
A business line of credit is a lot like a supersized business credit card. It’s another kind of revolving credit, which means you can wait to use it until you need to, pay off any draws you take, then borrow up to the credit limit again.
That said, there are some notable differences between the two types of funding. For one, credit limits tend to be higher for business lines of credit than business credit cards.
In addition to this, their interest rates tend to be lower, though it depends on the lender. Generally, online lenders have higher interest rates, while traditional financial institutions are more affordable.
Qualifying for a line of credit is also usually harder than getting a business credit card, though that too depends on the lender. Online lenders tend to be less restrictive, while banks have higher requirements.
In both cases, you’ll need to at least meet a minimum level of annual revenue and a minimum time in business to qualify.
Finally, there is no grace period for business lines of credit. That means as soon as you borrow against your credit limit, interest will start to accrue.
Angel Investors
Angel investors are another form of equity financing. Unlike venture capital funds, angel investors are usually individuals, though they may have an informal group of peers that they invest alongside.
They usually prefer to invest in a startup or entrepreneur earlier in their growth process than a venture capital fund would, so they’re a better choice for initial rounds of funding.
Like venture capital funds, they’re often willing to take on higher risk in exchange for a higher potential reward. They invest in multiple businesses and hope that at least one pays off big.
Because angel investments usually come from wealthy individual investors, you can’t just apply for their funding online. Many of them find their investments entirely off of referrals.
You’ll need to leverage your personal connections and network extensively to get yourself in front of the right people.
Be aware that angel investors usually like to be highly involved in the projects they invest in, so they’ll make good use of their ownership in your business.
Venture Capital
Unlike most of the other types of business funding on this list, venture capital is a type of equity financing. Instead of borrowing money and promising to pay it back plus interest, you sell shares of your company.
Selling shares allows you to avoid taking on fixed debt payments. However, it forces you to give up a portion of your future business profits and lets the investor have some influence over business decisions.
Venture capital firms pool money from wealthy investors and investment banks to buy shares of companies with high growth potential.
They’re willing to take on significant risks because they invest in multiple projects and count on the extraordinary gains from the few winners to exceed any losses.
If you’re willing to give up significant equity in exchange for hyper-fast growth, venture capital might be the key to scaling your business. As long as you don’t mind giving up part of the ownership and control of your company.
Crowdfunding
In general, crowdfunding includes any form of financing that relies on gathering low amounts of capital from a high number of people rather than indebting yourself or selling shares to a single party.
There are two popular variations today: rewards crowdfunding and equity crowdfunding.
Rewards crowdfunding doesn’t fit neatly into the debt or equity financing models.
Essentially, it involves requesting a donation to your company in exchange for a future reward, like a discount or free product sample.
Equity crowdfunding is a more familiar model. It’s a lot like an initial public offering (IPO) in which a company issues shares on a public stock exchange, except your company remains private.
Both types of crowdfunding generally require that you persuade a large group of people that your business has something worthwhile to offer.
SBA Microloan
The SBA offers many types of financing, not just traditional business loans. They also have a microloan program, which sponsors loans to small businesses up to $50,000. The average microloan is around $13,000.
Because they’re so much smaller than a traditional small business loan, you may find them easier to qualify for than other forms of debt.
Note that the SBA doesn’t lend the money to a startup or small business owner directly. Instead, they provide the funds to intermediary lenders, which are nonprofit community-based organizations with prior lending experience.
These intermediaries have their own underwriting process. They generally require some collateral and a personal guarantee.
Invoice Financing
As you might expect, invoice financing involves borrowing against your outstanding invoices. Lenders may follow slightly different models, but it usually looks something like the following.
You invoice your customer for a product or service on a net-30 or net-60 basis. You’ve completed your work and incurred expenses to do so, but you won’t get your payment for another month or two, at least.
In the meantime, you approach a lender and borrow a percentage of the outstanding invoice to bridge the gap. Once your customer pays the invoice, you pay off the amount you borrowed plus whatever fees and interest the lender requires.
Invoice financing is far from the cheapest form of business funding for startups, but it’s easy to qualify for compared to other credit accounts.
As long as you have invoices to borrow against, it’s a viable way to generate working capital and smooth out your cash flow.
Equipment Financing
Equipment financing is a type of term loan that helps you purchase whatever equipment your business needs to operate. However, it won’t do much else.
Generally, the price of the equipment you need to buy becomes the principal balance of the loan. That means you won’t get any more money than you need for the purchase.
In addition, whatever equipment you use the loan to buy with becomes your collateral for the account. If you default, your lender can seize it to recoup their losses.
It’s usually a good idea to match the loan’s repayment term to the equipment’s useful life. You don’t want to be making payments on something that’s no longer contributing to your business.
Both traditional banks and online lenders offer equipment financing. As usual, a bank loan will have better terms but be harder to get, while online lenders are happy to work with less qualified borrowers for a higher interest rate.
Friends and Family Loans
Borrowing from friends and family presents a unique kind of risk. However, it’s often much easier than getting a startup loan from a bank or attracting the attention of an angel investor.
Your personal connections are naturally more inclined to care about your success than anyone else. As a result, not only are they more likely to give you money in the first place, but it’ll probably be a better deal for you too.
In other words, they may give you an interest rate of 3% when a bank would demand 7% or ask for 5% of your business’s shares instead of 20%. Some might even be willing to give you money outright.
Before you go to your friends and family for startup financing, though, make sure the relationship can withstand a failed business transaction. They may be more willing to offer you loan forgiveness than a bank, but they probably still won’t be happy about it.
Personal Savings
Using up all of your personal savings usually isn’t the ideal way to generate startup capital. It can leave you penniless if your business isn’t as successful as you hope.
It’s also unsustainable since many people don’t have enough savings to comfortably fund the growth of a business and their personal needs.
That said, it has the advantage of being quick, easy, and completely permissionless. If you have excess cash or assets you can liquidate, it’s much easier to contribute them to your business than to get someone else to do it.
In addition, contributing your own money as seed funding is a sign of confidence to other potential investors. Many business owners add something of their own capital to their companies. Just make sure you don’t put in more than you can afford.
Grants
Last but not least, a grant is a sum of money that the government gifts to a business or organization to help them accomplish something. You don’t have to pay them back or give up any shares of your company in exchange.
For obvious reasons, if you can secure a startup grant, it’s probably the best form of financing possible. It’s as close to free money as you can get.
Unfortunately, getting a small business grant requires jumping through quite a few hoops. They have specific eligibility requirements and you’ll have to prove that you meet them to qualify.
For example, the Targeted Economic Injury Disaster Loan (EIDL) Advance is a $10,000 grant for businesses that:
- Applied for an EIDL loan
- Are in a low-income community
- Have 300 or fewer employees
- Can demonstrate more than a 30% reduction in revenue due to COVID-19
As far as grant requirements go, those are relatively minor, but they should give you an idea of how the process works. Generally, the best place to start looking for grants is Grants.gov.
Choosing the Right Funding Option for You
There’s a lot to consider before you decide on a financing option for your business. There are plenty to choose from, after all, and they have unique advantages and disadvantages.
Before you commit to one, ask yourself questions like the following:
- What kind of financing have I already acquired?
- How important is retaining ownership of my company?
- How much money do I need, and how fast do I need it?
- What will I use the money to accomplish?
- What types of financing are realistically available to me?
Your answers to these types of questions will help you determine which types of financing make the most sense in your situation.
For example, if you already have too much debt financing, you may want to give equity crowdfunding a try. Conversely, if retaining complete ownership of your business is your highest priority, you might try to apply for a grant.
Ultimately, there is no single perfect option for every startup or even the same startup at every stage of its development.
As long as your business survives, you’ll likely go through many rounds of funding over the years. Keep an open mind and be ready to adapt to the demands of changing circumstances.
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