We’ve all heard the corporate Cinderella story: a person who started with nothing began a business in their garage and became a multi-billionaire. But even this person had to have a bit of cash to make it happen. The old adage is true: it takes money to make money. Starting a small business is often about growing a dream into a reality. So where do you get the money to get the dream off the ground?
Below is an overview of the three most common funding sources for small businesses, how they work, and how to find them. Identifying all available resources is crucial to getting the funding you need to launch or boost a small business. Working with a qualified broker can make the hunt for funding easier and help the application process go more smoothly than trying to fly solo.
Friends and Family
In other words, crowdfunding. Whether you’re approaching a single wealthy benefactor or getting a little help from multiple people, there are some important guidelines to follow. Develop a business plan, a pitch deck (a quick presentation), and a specific amount you need to borrow before you start asking for money.
Your ideal “friends and family” crowdfunding investors will understand the risks involved with lending. They should also be comfortable with the amount of capital they invest. You don’t want your college buddy to invest his last dime in your business idea. Try to get funding from someone who can add sound business advice to the deal. That way, they’re invested in your business on another level that keeps them engaged.
Once you’ve got someone ready to invest in your business, treat the exchange like any other business deal. While getting a gift of money instead of a loan sounds nice, the IRS will hit you with a tax liability on gifts. Determine an interest rate (which you can get from the IRS website) and build a repayment plan.
When money is involved, relationships between close friends and family members can quickly turn sour. To protect both parties, create a clear contract so that you both know what to expect. The contract should have the interest rate, repayment schedule, and an exit strategy at a minimum. It’s important to hire an attorney for this step, even when working with people you know well. Having an attorney is a good idea since you’ll likely need their help in other areas of your business as well.
In addition to “friends and family” crowdfunding, you can seek money in the form of gifts or grants (people want to see your idea succeed), debt-based crowdfunding (individual lenders put money in and the interest rates and terms are determined by the lending platform), or advance ordering (your customer wants the product, and they won’t get it until the setup and production costs have been met).
These are often ways to get a new product to market, but they are not long-term funding strategies. Most often public crowdfunding is a first push that is used to create a proof of concept in order to secure other types of financing.
If seeking money through peers, family, or your targeted crowd of investors isn’t possible, or enough, private equity investors are another source of small business funding. Private equity includes “angel investors,” “venture capital,” and “vulture financing,” among others. These are funds from investors outside of friends and family and outside of public markets.
A private investor can be an individual but is more commonly a group of funds or private equity firms. They can be preferable to friends and family investors because they typically have more money to lend and know-how lending works. Equity investors exchange money for interest in your company. That means the investor has a say in how you run the business. How much of a say depends on the terms you negotiate.
To identify equity investors who are potential funding sources, look at investment bankers, professional investors, and other business owners in your industry. If you know of a successful entrepreneur who knows the ins and outs of your business type, they can be a great source of equity funds and guidance. Before accepting an offer, though, research the individual or company first. Make sure they can provide the funds you need and have the reputation you want to be linked to your business.
Equity investors aren’t likely to want to share their interest in the company with other investors. Once money comes in, you may be limited in other funding opportunities if your investors don’t agree or if they have other investment objectives. Be sure to clarify with the investor before you seek further funding or sign an agreement.
Commercial lending is a broad industry that supports all types of businesses. You’ll need to match the right loan with your business. Not all loans are the same, and each financial instrument a lender offers has an ideal purpose. You won’t want a long-term mortgage if you’re only looking to remodel your property. Similarly, a short-term hard money loan isn’t best if you want to buy high-performance equipment you expect to have long-term.
Commercial loans come from banks, credit unions, government sources, and private investors. Unlike equity investors, these lenders don’t want controlling interest in your business. They make money on their investment by charging interest on the loan. Generally, the shorter the loan term, the higher the interest rate and vice versa. Private loans are often easier to qualify for and come through quicker than bank loans. But, you could pay a higher interest rate for a private loan.
To get a commercial loan you’ll need to be aware of your credit score. Most loans also require a down payment. Check minimum qualification requirements carefully before you apply so you aren’t wasting time preparing an application for a loan you won’t qualify for. Lenders will want to see your credit report (private and business), tax records, organization documents, bank statements, and cash flow projections. See if you can get a checklist of documents before you apply.
Finding small business funding takes work. You must identify where you want to get funding, how to qualify for funding, and how to apply for it. Most lenders will only show you the loans or financial products they offer. If you want to compare loan offers, you have to go to several different lenders. But you don’t have to go through this long and arduous process if you work with a loan broker.
A loan broker works with many lenders to build relationships most business owners don’t have the time or need to do. They can show you a comparison of lenders without being biased as to who you decide to go with. A broker can also save you the time you might otherwise waste on applications that won’t go through. Even if you have a low credit score, your broker can show you how to raise it, so you’re better positioned to qualify for a loan.
The loan application process can be detailed and complex. Terminology isn’t always clear, there’s always fine print, and you can miss something critical if you’re inexperienced. You’ll also slow the process down if you don’t submit all the required documents with your application. If you use a tax professional to do your taxes, why not use a broker to find a loan? They can help you build an effective loan application package and eliminate the back and forth between you and underwriting.
Our brokers are an invaluable resource if you are seeking funding for your business. We help you find the right type of funding, from real estate investments to new construction, equipment financing, and on to working capital. Give us a call and we will help you target the right type of funds.