A complete guide to small business financing – get your idea off the ground!

Learn about investments, bootstrapping, loans, crowdfunding, and more!

Small business financing is a must for anyone looking to start their own business from scratch.

Many people have dreams of starting their own business. Maybe they have a great idea that they think could change the world, or maybe they have a hobby they think they could turn into a career?

Whatever the case, there is a fair chance you’re going to need cash in order to finance that idea. Most businesses won’t start generating profit right away, which means you’ll need to find money from somewhere if you want to rent an office/warehouse space, buy materials and inventory, market your products, pay staff or freelancers, or even get hosting for a website. This can add up to a lot of cash in some cases!

Small business financing

But if you’re just one person with a full-time job and lots of financial commitments, how can you generate those kinds of funds? Read on to discover how to finance a small business, and get one step closer to turning your dream into a reality.

How to finance a small business

There are lots of small business financing options for those that know where to look, and chances are there’s at least one that’s a good fit for your purposes. Here are some of the best strategies available.

Self-funding

One small business financing option is simply to take your own savings and then funnel them into your business idea. How viable this option depends on the amount of up-front investment you need, as well as the amount of money you have in the bank.

How to finance a small business

The big benefit of self-funding your business idea is that you will own 100% of your business, you won’t have any commitments to fulfill, and you won’t have debt to pay off. The other benefit is that this process is much simpler than other small business financing options, and there’s no one to tell you “no.”

On the other hand, though, self-funding this way involves a large personal risk. If your business doesn’t take off, then you will have lost your life-savings!

Bootstrapping

Bootstrapping also means funding yourself – the name refers to pulling yourself up by your own bootstraps! This time you’re not using life savings, but rather designing your business to generate cash quickly with minimum overheads or investment. You then develop it further as the money comes in.

If your goal is to create a AAA video game but you don’t have the funds available for example, try selling small mobile games that you can build quickly in order to generate the cash you need to hire a team, invest in better tools, and quit your day job.

It involves minimal risk and gives you complete agency.

You can even set up more than one business. How about becoming a freelance writer and then using the profits from that to fund your own clothing line?

Bootstrapping is my favorite option on this list by far because it involves minimal risk and gives you complete agency. Even if you never create the ambitious business of your dreams, the process of bootstrapping itself will be a valuable learning curve! In other words, the worst-case scenario is that you run a small business for a while but it doesn’t lead anywhere.

Crowdfunding

Crowdfunding means you are crowdsourcing your finances: instead of getting one very big loan from a single lender, you are instead getting lots of smaller or grants from hundreds of people. If one hundred people give you $10, then that gives you $10,000 to start your company!

Successful kickstarter

To crowdfund a project, you’ll use a site like Indiegogo, or Kickstarter. These sites allow you to post an idea for a project you’re creating and then collect pledges from “backers” who want to see it become a reality – normally in exchange for some kind of freebie or other incentive. Very often this amounts to taking pre-orders, though you can offer different tiers of rewards for those that are more or less invested in the concept.

To be successful with crowdfunding, you will need to create a video and written pitch explaining your business idea and why you are the right person to handle its execution. You’ll also need a prototype, which you usually create quite simply with the help of a manufacturer, 3D printing, or some DIY. Ideally, having a ready-made audience thanks to a high profile social media presence will also help!

Crowdfunding has a lot of amazing benefits but also a few downsides. The biggest advantage is that you are getting a lot of upfront investment without giving away any share of your business, or accruing any debt. But this isn’t the same as getting small business financing for free: you’ll be making commitments to your backers, taking preorders, and involving them in the creation process. That means you need to ensure you meet the deadlines you set for yourself, and handle any hiccups or interruptions carefully so as not to upset backers.

Kickstarter financing

Crowdfunding helps you to generate hype for your product and may even lead to media coverage. It also helps you to validate your idea and test the market: if you don’t get the funding it likely means your idea wouldn’t have generated much cash anyway!

It’s not easy though. To be successful here, you’re going to need to do a lot of marketing, and you’re going to need an idea that people are truly excited for.

Friends and family

Also referred to as “primary sources” of small business financing.

Why ask strangers for money though, when you could just ask your friends and family? How about the reliable “bank of Mum and Dad?” Or what about granny and grandpa?

This might seem like a bit of a cop-out, but it actually makes sense in many cases. Most parents want to see their children succeed, and many of us have friends that are in a position to help out too. Usually, our loved ones would rather that we didn’t put our personal finances/credit score at risk, and want to help us achieve our dreams.

This doesn’t have to be a hand-out

This doesn’t have to be a hand-out either: you can make this into an investment opportunity and potentially help everyone earn a little cash from your ideas.

Just keep in mind that this is a very big responsibility and that you are now going to be risking money that isn’t your own – that someone has lent or given you out of the goodness of their heart. Of course, it also requires that you know someone who is willing and able!

Business loan

At this point, you have about run out of options that don’t involve debt or giving away parts of your business.

If you aren’t able to get the small business financing you need using any of the methods mentioned, then getting a business loan might be your best course of action.

A business loan is, of course, a loan that you are given by the bank, normally with the understanding that you will use it to build a business. This loan must be paid back with interest, and the hope is that you’ll gain that interest thanks to the success of your business idea.

The hope is that you’ll gain that interest thanks to the success of your business.

To get a business loan, you will need to find a bank that offers them and then visit in person with an outline of your business, your projections, expenses, etc. If you impress the decision-maker, they’ll provide you with the loan and the terms that detail when you need to pay it back and with what interest.

It is possible to get a business loan as a sole proprietor (a one-person business), but this is typically a little harder than it is for limited companies. The reason for this is that banks view sole proprietors as being higher risk. Not only that, but many sole traders do not require the same kind of up-front investment that is required for larger businesses.

Note as well that as a sole proprietor, you will be legally responsible for any debt you take on, making it more of a personal risk that could end with the loss of property.

There are a few different types of small business financing loans:

SBA loans

An SBA loan is a loan backed by the Small Business Administration (SBA). They will back loans ranging in value from $5,000 to $5 million to help support the grown of small businesses in the US. These loans are provided by online lenders and commercial banks, and the government steps in to help lower APR rates. Interest rates are typically as low as 5-13%, with long term monthly repayments (up to 6 years for a microloan of $50,000 or less).

You will need a good credit score to be considered for this type of loan however, and the application process can take several months in some cases.

Business term loan

A business term loan lets you borrow a sum of money ranging from $1,000 to $500,000 and repay that over the course of several years. Interest rates typically range from 7% to 30%. These loans can be approved in a couple of days, don’t require collateral, and can be used for any business purpose. However, they often incur an early repayment charge and will be dependent on your/your business’ credit history.

Business line of credit

This works like a credit card for businesses and is available to those with slightly lower credit scores. You’ll be approved for a specific amount of credit, and you can then draw on that as you need it. As you repay the money, you can then withdraw more. APR rates range from 7-25%, with repayment terms usually falling between six months to one year. This type of funding is highly flexible and available quickly, but large penalties are incurred for late payments.

Grants

A grant is in many ways the ideal option for small business financing. This is the only true example of “free money” to start your business with, provided by the government or a charitable organization such as a trust.

Small business financing grant

This is money that is granted toward a good cause. From the perspective of the US government, small businesses are good causes in general, seeing as they can help advance technological understanding and fuel the economy. A good place to start would be the SBA. Programs here include the Small Business Innovation Research Program (SBIR) for small businesses that seek to “explore their technological potential,” and the “Small Business Technology Transfer Program,” that once again focusses on

You can find a list of alternative grants here. This one includes programs offered by the Department of Energy, NASA, and even Walmart!

Personal loan

While business loans are intended for funding start-up ideas, there is often nothing to stop you from using a personal loan to get your business off the ground.

Many major loans will prefer you to use a personal loan only for personal use, but often the line becomes blurry. For example, if you’re buying a laptop then this could be considered both a personal purchase and a business investment. Many entrepreneurs will therefore use credit card loans and the like in order to gain funds for their dream projects – a story you hear often on Dragon’s Den.

Personal loan business

Keep in mind that this is a risky strategy and not one that is generally encouraged. Some banks do allow personal loans to be used for business purposes, and of course these are the best kinds to look for if that is your plan.

Otherwise, you should think very carefully about the type of loan you take out. Payday loans, for example, are ill-advised at best and predatory at worst and can end up crippling you financially. These are categorically not suitable for small business financing.

Angel investor

Angel investors are essentially well-off individuals rather than large businesses, who want to provide capital for start-ups. This of course is where the word “angel” comes in: it’s like they’re your own personal angel helping you to make your dreams and ambitions reality!

But of course they’re not really angels, so as you might suspect, they will generally ask for something in return. This will either be convertible debt or ownership equity of the business. “Free” money is not an investment but rather a grant. The precise terms of your agreement will of course vary and in some cases you will find you get a great deal that benefits you. In other cases you can end up giving away more of your business than you should do and racking up large amounts of debt.

It's like they're your own personal angel.

Another thing to consider is that some angel investors will want to take a “hands on” approach and will offer their experience, contacts and advice, whereas others will sit back and trust you with their investment. Try to decide whether you want the extra help, or whether you’d rather maintain full autonomy.

Why Angels? 

So why use angel investments rather than venture capital from a big investment firm or a bank loan? One aspect is the personal angle, which can make it easier in some cases to be successful. Trying to get a large firm to believe in your crazy idea might be impossible due to the sheer number of voices and competition. On the other hand, if you can identify an angel investor with experience and interest in your area, and if you can make a personal appeal that demonstrates your passion for what you’re doing, then it might be easier to get them on board. This is the most important thing when trying to find an angel investor for your business – do your research and let your passion show in your pitch.

Another benefit of angel investors is that they can sometimes bring their unique skills and experience to the table as mentioned above. This won’t always be something you want, but in the right circumstances, it can give your business that boost and a real fighting chance. You might even find that a deal with a well-known investor could give you some free marketing and coverage in the media – vindicating your idea by association.

An angel investor can also be a friend or relative, or maybe someone you met at a conference. Alternatively, you can find angel investors through websites like AngelList. Angel investors do not need to be accredited, but if you do not know the individual in question, then it can be a good idea to look for an accredited investor.

Venture capitalist

A venture capitalist (VC) is similar to an angel investor, except they tend to be less hands-on and can be considered serial investors. They typically won’t invest out of their personal finances, but will instead use a pool of cash from investment companies, large corporations, and pension funds (referred to as syndicates).

Because venture capitalists are drawing on a larger resource, they usually have access to more funds as compared with angels. According to the SBA, the average angel investment is $330,000, whereas the average VC invests $11.7 million. That said, VCs are typically a little harder to impress, don’t provide personal help and support, and may ask for a bigger return (20-35% versus 20-25%). VCs might also require you to create a board of directors in order to give them a seat.

It’s also worth noting that angels and VCs will typically invest at slightly different points in a start-up’s life. Angels tend to provide pre-seed capital, meaning that they offer financing for businesses that are still in the earliest stages (perhaps little more than an idea).

VCs on the other hand will usually invest in companies that are already established. This is known as seed capital, or series A funding.

Accelerator

Accelerators are programs offered by organizations to provide startups with access to small business financing as well as mentorship, training, office space, and equipment. This is offered in exchange for equity.

Accelerator

Incubators are similar but are often run by not-for-profit organizations. These organizations may not ask for equity in the business and often won’t limit the amount of coaching and support they offer. Incubators are even more sought after than accelerators then, though it can be tough to land a spot.

Some more considerations

Now you know how to fund a small business, it’s time to assess these options and decide which is the best fit for your plans and goals.

There are a few other things to keep in mind though, before you go ahead. Firstly, you should spend some time drawing up a business plan first. You’ll need to show this to investors and lenders anyway, so it’s good practice. Moreover, your business plan should advise you on how much money you need to ask for, and when you’ll be likely to be able to pay it back. You should also include the cash injection and the debt you’ll incur. Consider everything that could go wrong too, and make sure you get enough money to handle every contingency.

How to fund your small business

You should also develop what is known as a minimum viable product (MVP). This is the most basic version of your idea you can create quickly and cheaply in order to sell. This can be used for demonstration purposes, but also to test the market and gain feedback before you develop the concept further.

The options in this list focus on companies in the pre-seed and seed stages. That means you have met the requirements above, but have not yet launched or have only just begun selling.

You’ve made the big time!

After this, your business will enter the growth phase. You’ll now have a better idea of your product, market, and projections, and can start to find bigger sources of small business financing. At this stage, most companies will enter the following rounds of funding:

  • Series A – Here you typically raise between $1-10 million and give away 15-30% of the business.
  • Series B – Here you focus on scaling the business, giving away more shares in exchange for bigger and bigger cash injections.
  • Series C – This is for fully mature businesses only, with an expanding customer base. The funding rounds can now generate hundreds of millions of dollars and beyond.

After this point, the company will be ready for acquisition or initial public offering (IPO). In other words: you’ve made the big time!

But let’s not get ahead of ourselves, eh? How about focusing on small business financing for now!

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