7 Ways to Finance a Small Business Startup

How to Finance a Small Business Startup

How to Finance a Small Business Startup

One of the key factors you need to consider when starting a small business is where you will find the money to fund the business. Small business financing has changed dramatically over the past decade and today’s entrepreneurs have many more options than business owners in the past.

Today, I want to share with you 7 of the best small business funding options you’ll have when it comes to financing your new business.

But first, let’s talk about whether or not you really need a small business loan to get started.

Do I Need a Small Business Loan?

It’s a misconception that everyone who starts a new business needs to borrow money. In fact, some businesses can be started without a lot of capital, or the owner may choose to bootstrap the business.

If you’re unsure of whether or not you need to borrow money for a new startup, answer the following questions to help you get some clarity.

·         Does your new business need to carry a lot of inventory? If you’re opening a retail shop or online store that carries its own inventory, then chances are you’ll need to borrow some money to purchase the products. But if you plan on drop shipping your products or opening a service business that doesn’t carry products, you might not.

·         Have you figured your startup cost projections? You can’t know whether or not you need to borrow money until you’ve completed your startup cost projections. These numbers will tell you exactly how much money you need to start and maintain your business. Once you’ve completed them, you’ll have a better idea of how much capital it will take to start and run your new business.

·         Have you exhausted all your personal funds? If you can use your personal funds to start your business, it’s better because the business won’t be weighed down with a lot of debt. I’ll talk about some of those options below that you may not have considered.

Where to Find Small Business Startup Funding

If you’ve decided that you will need to look for small business loans, take a look at the startup financing options I’ve listed below. You have many choices when it comes to funding a small business, so be sure to take your situation into account and choose the small business loan that’s right for you.

1. Borrow from Friends or Family

I see a lot of experts warn people about borrowing small business capital from friends or family because they say it could potentially harm their relationships. I take a different approach. As long as you treat the transaction like a business deal—and stick to what you promise—I see no reason why this can’t be a viable and important way to get startup capital. After all, Jeff Bezos not only started Amazon.com in his garage, but he borrowed money from his parents to do it.

If you’re going to take this small business startup loan option, be sure to follow these guidelines.

·         Approach them like a business person. When you approach a bank for a business loan, you prepare and present your business idea to them in a way that allows them to analyze it before making a funding decision. It should be no different with your friends and family. Present them with your research and business plan just as you would any other investor. This will not only gain their respect, but it will give them all the information they need to make an intelligent decision based on the facts.

·         Don’t pressure them into a decision. Rather than asking them to make a decision on the spot, tell them that you will leave the information with them so they can think about it. Whether you succeed or fail in your venture, you want your investors to own the decision they made, and if you pressure them into a “yes,” that could cause them to harbor resentment towards you if you fail.

·         Make it legal. Whatever you do, don’t come to an agreement on a handshake. You will need to draw up legal documents just like you would if you were borrowing from a bank or other investor. This will prevent misunderstandings from occurring in the future, which could put a damper on your relationship.

·         Keep your word. Finally, whatever terms you agree to, it’s imperative that you keep up your end of the bargain. If you promise them a percentage of the profits, you’ll need to provide them with financial reports on a regular basis to show what the company is earning. If you agree to a payback schedule, make it priority to never miss a deadline.  And if you get into financial trouble, be sure to talk to them about it immediately instead of avoiding them.

2. Use Credit Cards to Fund a Small Business Startup

One small business financing option you have is to use your personal credit card to fund your business. It’s estimated that about half of the startups in the US use credit cards to finance their business. Using credit cards to fund a new startup is fast and you won’t have to jump through a lot of hoops to use them, but although this method of funding a business is readily available to many, it doesn’t come without risks.

For starters, if your business fails or you are unable to meet the minimum monthly payments on the credit card, your personal credit will be at risk. And while it would be better to get and use a business credit card, chances are you won’t be able to when just starting out because your business won’t have a credit history. To change this, you can apply to vendors such as office supply stores and then build your business credit from there.

Another risk with using credit cards to fund a small business is that those minimum monthly payments can add up quickly if the interest rate is too high. For example, if you financed $20,000 on a credit card that charged 23 percent interest, your monthly payment would be about $583.00. That’s a big chuck of change when trying to get a new business off the ground.

Many people have achieved success by using credit cards to fund a business, but they approached the funding method cautiously and carefully. If you’re thinking about using this option to fund your new business, be smart and let the credit cards work for you, not the other way around.

3. Use a 401K or Other Retirement Plan for a Small Business Startup

If you have money in a 401K, 403(b), SEP, TSP, or Keogh you may be able to use it to fund your business. But be warned, if you decide to go this route and your business fails, you will not only lose your business, but your retirement savings as well.

The IRS has a special plan called ROBS (Rollover for Business Startups) that allows entrepreneurs to use their 401K retirement plan for a business startup. If you meet these requirements, you may be able to use your retirement funds to finance your small business.

·         You must own the retirement account. If your 401K or other retirement plan is set up by your employer and they control it, you cannot use it to fund your startup. This only works if you have an individual account, or if you’ve recently left your job but still have the account.

·         Only certain types of retirement plans are eligible. Your money must be in one of the types of retirement accounts listed above to be eligible. If you have retirement funds in another type of account, consider converting it into one of the eligible types.

·         You will not have to pay fees. If you’re not yet 59 1/2, and withdraw funds from your retirement account, you will have to pay income taxes on the money you withdraw, as well as a 10 percent penalty. But if you’re using the ROBS program, those fees are waved. In addition, because this is not a loan, you won’t have to burden your new business with interest payments.

There are some very specific steps you’ll need to follow to stay on the good side of the IRS when using this program, and I recommend that if you plan to use your 401K to finance a startup, you meet with a financial planner to get it right.

·         Your new business must be set up as a C corporation. Because different states have various law on how to do this, you may need to hire a lawyer to do it right. Once set up this way, you’ll need to designate a board of directors, officers, shareholders, resident agent, and file articles of incorporation.

·         Open a 401K plan for your business. Make sure the business 401K plan you open has a profit sharing plan that allows 100 percent of the assets attributable to rollovers to be invested in employee stock.

·         Make the transfer. Transfer the funds from your personal 401K to the business 401K and then invest it in your company’s stock.

Some experts say that using retirement accounts for small business startups increase the likelihood of an IRS audit, so make sure that if you use this funding method, you do it correctly.

4. Get a Bank Loan for a Small Business Startup

Even though bank loans have become more and more scarce for small business owners because banks have tightened the lending process considerably, there are still instances when a bank loan may make sense. For example, if you have a perfect credit score, a well-thought out and persuasive business plan and at least 30 percent of the loan amount as collateral, a bank may give you a second look.

And some types of banks are beginning to loosen their purse strings in order to provide small business loans to entrepreneurs. For instance, credit unions are said to be making small loans at twice the rate of large banks.

If you think you could qualify for a bank small business loan, this should be your first step because the interest rates and fees are considerably lower than other lending sources. But plan ahead if this is your first choice because the wait times are longer than the newer, alternative forms of startup funding.

5. Use SBA Startup Loans to Fund Your Business

The Small Business Administration (SBA) itself doesn’t lend money to anyone, but it partners with traditional banks and micro lenders to lend money to entrepreneurs looking for new business loans. The rates are typically lower than most traditional bank loans because the SBA guarantees a portion of them, so the banks know that at least some of the loan will be repaid even if the business goes under.

These loans are great for people who can’t quite qualify for a traditional bank loan, but still want lower interest rates and repayment terms. In order to quality for a traditional SBA startup loan, you must have good credit (a credit score of at least 720), some collateral, and some business experience. SBA micro loans are for those who don’t have stellar credit. The SBA offers a state-by-state list of approved micro loan lenders on this PDF.

Here are a few facts about SBA loans:

·         SBA offers micro loans with a cap of $50,000.

·         SBA offers its signature 7(a) loan for startups that have a little more experience and better credit. They typically range from about $500 to over $5 million.

·         APRs start at 6.5 percent and go up, depending on the credit history of the borrower.

·         It can take 3 weeks to a few months to apply for and get an SBA loan.

·         Repayment terms are typically 10 years, but can range from 5 to 25 years.

6. Get a Microloans for a Small Business Startup

The SBA isn’t the only organization offering microloans for small business startups. You can find these easier-to-quality-for loans from a variety of sources.

Microloans are easier to qualify for, and are intended for people who need a small amount of startup cash (Typically under $50,000). While you still need an acceptable credit score, you won’t need perfect credit to be approved. And although you will still need to submit some basic documents such as a business plan, the requirement aren’t as stringent as traditional bank loans. Depending on your credit history, you may be asked to provide collateral, or if you don’t have any, a personal guarantee for the loan amount.

Microloan lenders tend to look at your potential rather than your experience, and that makes these loans particularly good for entrepreneurs in the startup phase. Some of the places that offer microloans are Kabbage.com, Lending Club.com, and Prosper.com. Both Lending Club and Prosper are peer to peer lending, which means investors will look at your proposal and decide if they want to fund a portion of your business. Kabbage is a direct lender.

7. Use Crowdfunding and Equity Lending for Small Business Startup Funds

A creative business owner can go to sites like KickStarter.com and Indiegogo.com and ask for funding in the form of gifts. For example, someone wanting to write a book could describe the project, ask for donations, and then give donors gifts such as a signed copy of the book or a lunch with the author. This is still a great way to raise startup capital for a creative business. Because the money is donated in exchange for gifts, there is no repayment and that’s a major benefit for any new business owner.

But in 2013, the JOBS Act was signed into law, and it changed the playing field. The new law allowed entrepreneurs to seek investment funds from accredited investors on crowdfunding sites. The accredited investors must have earned $200,000 in the past 2 years or have $1 million in net worth, apart from their primary residence.

Then, in 2016 the law was expanded and now anyone can invest in startup companies. People whose net worth is less than $100,000 can invest a maximum of $2,000 or up to 5 percent of their net worth or annual income, whichever is less. And those making more than that can invest 10 percent of their net worth or annual income, whichever is less.

This has opened up startup capital funding for entrepreneurs all over the country because they no longer have to go to a bank or other lender, but can pitch their business idea directory to investors.

Sites like Crowdfunder.com, equity.indiegogo.com, and Wefunder.com allow everyday people to invest in startups. If you have a business idea that will appeal to the masses, this may be the startup funding option for you.

Now It’s Your Turn

Starting a new business is one of the most exciting things in the world, but in order to become a success, you have to have the financials nailed right from the start. These 7 small business startup finance options are all great ways to get the capital you need for your new business.

Have I missed any small business startup funding options? If so, please tell me how you found startup capital for your business in the comments below.