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E

very entrepreneur understands the importance of funding in launching and growing a business. Aside from providing an infusion of cash for day-to-day expenses, funding sources can unlock several additional benefits for business owners, like access to advisory services and an increased marketing budget.

However, not all funding types are identical, as different sources carry different requirements of the business owner. Different funding types have different lead times, as well; some may be immediate (i.e., self-funding via the owner’s personal credit card) while others can take more than a year (i.e., grant programs).

Entrepreneurs should learn as much as they can about the funding market, and prepare their business documents for when they need to apply. In this article, we’ll cover types of business funding, what you’ll need to apply for funding, and how to evaluate the right funding options for your business.

Assessing your funding needs

It’s important to first evaluate why you need funding in the first place. While all businesses require some form of start-up capital—at the very least to pay the Division of Corporations in their state to incorporate, for example—not understanding your business’s financial needs can be a waste of time and can lead to applying for funds you don’t need or that are insufficient.

To determine how much funding your business needs, look at some of the major costs associated with getting up and running and keeping operations running smoothly:

Wages for employees or contractors

Paying employees and contractors is perhaps the most significant cost to businesses of any size and in any industry. When applying for funding, consider how many employees you will need now and in the short to medium term, and how much you reasonably expect to pay them. Also, you will need to draw a salary as well. The more detailed your payroll needs are, the more compelling and convincing your applications will be for funding.

Rent, utilities, and equipment for your physical space

Many small businesses start from the entrepreneur’s home, but eventually, you’ll likely need a physical space in which to produce, deliver, sell, and manage your products and services. Do as much research as possible to secure the most attractive prices you can on a commercial space and its associated costs, such as utilities, supplies, and equipment. This demonstrates to funding sources that you have performed a thorough analysis and assessment of your costs related to your physical space.

Inventory or cost to produce goods or services

Calculate the cost to acquire or create products, or to deliver services (this is more likely tied to the salaries of your employees delivering those services), and how much capital you need to get these products and services to customers. Detailed information about your business’s costs can help demonstrate to lenders and others that you have a thorough understanding of your industry and market.

Marketing and growth

A small business needs to attract and acquire customers. Sales usually requires marketing tactics used to initiate and foster those sales—i.e., a website, Facebook Page, or Google Ads—so an acquisition plan, along with the anticipated costs of carrying out marketing initiatives, will be important to show lenders when seeking loans or external funding.

Types of small business funding

A lot of business owners think that funding means bank loans. However, entrepreneurs are often surprised to discover that multiple funding sources abound and that they can access a mix of funding sources depending on their business’s needs.

1. Self-financing

Perhaps the most obvious funding source is yourself: using savings and even available credit on credit cards to launch your business or pay for emergencies as they arise.

While bootstrapping your business seems like the most obvious, initial strategy, it’s important to keep records and accounts separate as soon as possible. As the business grows, payments and cash flow will grow in size and frequency and need to be kept separate from personal accounts.

2. Loans and other debt financing

There are a variety of financing options available to businessesSBA loans, merchant cash advances, and term loans, to name a few. Because startups and new businesses do not have a credit history, the lender will most likely look to your personal credit when deciding whether to give you a business loan. As such, a strong credit score is usually necessary to not only secure a business loan, but also obtain one with a favorable interest rate. 

Another bank option is to apply for a credit card tied to your business. As with the loan, your personal credit score will be used to determine eligibility. As a revolving credit facility, the credit card can help you build your business’s credit profile, bolstering your ability to apply for larger loans down the road, if needed.

3. Equity financing and venture capital

Venture capital is a form of equity financing used by startups and small businesses that do not have any current, physical assets (i.e., products or real estate) but anticipate high growth due to IP or some sort of intangible asset that has not yet been proven in the market. As such, venture capital is usually a funding route for technology startups. 

In return for investing in a company, venture capitalists take an equity stake in a company and  ask for a leadership position in order to more closely manage the company and accelerate the return on their investment.

4. Equipment financing and leasing

Equipment leasing entails renting equipment (machinery, vehicles, office equipment, restaurant equipment, tools, etc.) from a manufacturer or distributor. When you lease equipment, you pay a monthly fee to the lessor. Interest rates on leased equipment are typically fixed. This is often a more affordable alternative to a loan. Depending on the lease, you may be able to purchase the equipment at the end of the lease term.

Alternatively, you can seek equipment financing. Equipment financing refers to loans a business takes out to purchase necessary equipment. The equipment purchased serves as collateral for the loan, and interest rates vary based on the lender and loan terms. A number of institutions offer equipment financing, including banks, equipment financing companies, and online lenders.

5. Borrowing from friends and family

An alternative to traditional financing methods, getting loans from friends and family can be a great option when you are just starting out. Though this method likely won’t require the extensive documentation and repayment rigidity that accompanies traditional loans, it’s important to structure the investments in a way that works for all parties involved. Make sure to devise and stick to a repayment plan to demonstrate your commitment. Alternatively, consider offering equity to your investors. Without a solid plan of action, you risk straining personal relationships.

6. Invoice Factoring

Factoring is an advance on the value of your business’s outstanding invoices.

Factoring companies purchase some or all of your accounts receivables outright for up to 95% of their value. The factoring company then is responsible for collecting payments from your customers, making money off of the difference between the total invoice value and the discounted sale price. If you’re in need of additional working capital in the short term, this could be an option for you.

A factoring company is a third party that is willing to purchase part or all of your receivables at a discount. The factor then owns the outstanding invoices and collects from your customers. The factor profits from the difference between the discounted rate negotiated to buy the receivables and the full amount collected from the customer.

Not all businesses are eligible for invoice factoring. It’s suitable for businesses with several customers making predictable payments.

7. Community and government microlenders

Many local governments offer small business microloans (loans up to $50,000) as part of their economic development initiatives. These loans typically have low interest rates, offer more flexibility than traditional loans, and aim to promote financial inclusion in underserved communities. Microloans are an ideal option if you don’t need a large amount of capital and meet eligibility requirements. Additionally, many microlenders offer financial education and other support services to qualifying small businesses. 

These institutions may also offer grants, which do not have to be repaid. Search for available grants on websites like grants.gov and eda.gov.

8. Crowdfunding

Crowdfunding is when businesses receive funding through small donations from a large group of people. Most of these crowdfunding campaigns happen via Internet platforms, such as Kickstarter and Indiegogo, and have set time frames for when money can be raised and withdrawn, along with strict rules as to the types of businesses permitted on their platforms.

Crowdfunding appeals to entrepreneurs because it is usually donation-based, in which contributors give money without receiving anything in return, or reward-based, in which contributors receive products or services in return for their donations. Typically, no loans or equity stakes are involved.

Crowdfunding also offers innumerable digital marketing opportunities, as the crowdfunding platforms themselves invest large sums to promote themselves and the businesses running campaigns. Oftentimes, a successful raise is an endorsement of the viability of a business, which can be used to seek additional funding sources.

Preparing to apply for funding

Once you have selected the funding sources you wish to pursue, it’s best to assemble all of the necessary documentation. While no two funding sources are alike, most will require you to demonstrate the potential for success. 

The following information sources will help you present yourself and your business in the best possible light in front of banks, lenders, investors, and even strangers on the Internet (for say, a crowdfunding campaign):

  • Business plan
  • Financial statements and projections
  • Profiles of the senior leadership team and key employees
  • Hiring strategy and pay structure
  • Details, including the price points, about the products and services you wish to sell
  • Inventory and cost of goods or services you wish to sell
  • Roadmap for future products and services to be developed and sold
  • Analysis of industry or local competitors
  • Personal financial status, including credit score

Evaluating the right funding source for your business

Once again, no two funding sources are identical. Aside from disbursing funds, all have different requirements, restrictions, and terms. Business owners need to research all funding options and compare their pros and cons before moving forward with applications.

It’s also important to seek funding sources that align with your industry and business model. In some instances, only some funding sources will be available.

For further insights, network and meet with other entrepreneurs to determine which funding routes make the most sense. While the lenders, leasing companies, or venture capital firms are also a source of information, it’s in their best interest to position themselves as the most attractive, when they might not necessarily be the best route to consider. 

Below are some questions to ask yourself and your business partners to help you determine the right funding source for your business:

  • How much funding can the lender or investor provide?
  • How quickly are funds disbursed?
  • What is the payback period, if any?
  • What is the interest rate charged (if applicable)? Is this higher than the industry’s current rates?
  • Will the lender or investor take an equity stake in the business?
  • Will the lender or investor have any say or control in your day-to-day business decisions?
  • Will taking funds from the lender or investor be something you can use for marketing or promotional purposes?

Once you fully understand the application process and requirements for each funding source, the next step, of course, is to go through the application process. Submitting a solid, professional application ensures that you have controlled as many variables as possible. 

Final Thoughts

With so many resources and tools at your fingertips, researching and applying for funding needn’t be a daunting task. Rather than be discouraged when one source becomes a no-go, small business owners can rest assured that other options abound.

As a best practice, have all of the necessary documents handy before deciding to apply. The right bookkeeping and accounting systems, for example, ensure easy access to numbers when you need them. Keeping track of all programs to which you’ve applied, including the feedback you may have received along the way, can be instructive for improving your business in ways you may not have considered. As such, the process of applying for funding can in the end provide you with much-needed insights.

Novo Platform Inc. strives to provide accurate information but cannot guarantee that this content is correct, complete, or up-to-date. This page is for informational purposes only and is not financial or legal advice nor an endorsement of any third-party products or services. All products and services are presented without warranty. Novo Platform Inc. does not provide any financial or legal advice, and you should consult your own financial, legal, or tax advisors.

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