Financing

There are multiple financing options available for entrepreneurs and small business owners. No one method is recommended over any other. Each option has its own risks, costs, and benefits. When looking for funding, weigh each option against your own specific situation.

It is important to do your own research and develop a realistic operations budget to determine your actual financial needs. You may not be able to borrow sufficient capital to start and operate your business through its start-up phase. Regardless of what method you choose, seek the assistance of legal and financial professionals to guide you through your journey.

The following is a table detailing the different available options. Grants are not mentioned because they are not usually a source of funds for starting a for-profit business.

Financing Option Description
Your Own Money Personal assets may be used to capitalize your business. Savings, retirement funds or the sale of assets and investments may be sources of financing. Borrowing against the equity in your home or using consumer credit cards are possibilities, too. There are risks involved with borrowing against home equity, which should be carefully weighed with the assistance of a qualified professional.
Friends and Family Friends and family members may loan you or gift you money to start your business or they may invest their personal savings or other assets in your business. Terms of the loan or the investment agreement should be decided in advance and should be documented.
Vendors and Suppliers Businesses that supply your business with inventory and supplies may be willing to extend you credit. Generally, inventory or supplies are delivered to you under the agreement that you will pay the supplier in 30 to 60 days. As a new venture without a track record, however, this will be an extremely difficult source to secure unless you have had a good prior working relationship with the supplier.
Financial Institutions Regulated Financial Institutions (banks and credit unions) provide a variety of financial services to individuals and small businesses including lines of credit, term loans and mortgages. For new ventures or business with little history, financing is primarily based on the borrower’s ability to repay the loan. As the businesses grow, personal assets and financing will still be heavily considered, but the bank will begin to rely more on the business’s ability to generate revenue for payments.Your loan proposal will be evaluated on:

  • Relationship with the bank
  • Management
  • Collateral
  • Owner Equity
  • Cash Flow
  • Credit History
Government Guaranteed Loans The US Small Business Administration (SBA) provides loan guarantees under its 504 and 7(a) programs. These programs are administered through regulated financial institutions or community development corporations (CDCs). Also, there are available State, County and City loan guarantees and other local financing programs.The 7(a) Term Loan is the most common type of loan backed by the SBA. Loan proceeds can be used in various ways including working capital, inventory purchase, expansion, etc. The SBA guarantee is between 50% to 85% of the loan to the lender depend on the type of loan, loan amount, and term. The interest rate ranges from 2.25% to 6.5% over the current prime rate. You can apply for up to $5 million on a 7a loan, with terms ranging from 7 to 25 years.

The 504 Loan Program provides financing for owner-occupied real estate or for long-life fixed assets such as equipment. The 504 program works by distributing the loan among three parties. The business owner puts up a minimum of 10%, a conventional lender (typically a bank) lends 50%, and a Certified Development Company (CDC) provides the remaining 40%. Interest rates are competitive with current commercial real estate rates. The term of the loan can be up to 20 years.

The State of California Small Business Loan Guarantee Program (SBLGP) works to help businesses create and retain jobs, while at the same time encouraging investment into low- to moderate-income communities. The purpose of this program is to encourage local banks and non-bank lenders to make small to medium-sized business loans that are not traditionally bankable by providing the lender with additional security for a credit request in the form of a guarantee, which serves as an incentive to approve a commercial credit request it might not normally consider.

Community Development Financial Institutions A Community Development Financial Institution (CDFI) is a financial intermediary that offers a range of financial services and programs to accomplish their primary mission of community development. Most commonly, CDFIs provide credit access to people considered “unbankable” through revolving loan or micro-loan funds. CDFI services are generally targeted at specific populations (e.g. people who will operate their business in defined neighborhoods or people within a certain income range) with loans, usually under $25,000. There are other organizations which are classified as CDFIs, but they are not financing sources for most micro or small businesses.
Business and Industrial Development Corporations A BIDCO is a non-bank financial institution that provides assistance with financing as well as strategic consulting to small and medium sized companies. Businesses that do not currently qualify for conventional lending, may need a level of subordinated debt to qualify for additional bank funding, or are seeking expansion and need strategic planning may consider BIDCO financing. Viable candidates will have experienced management, two or more years operating history, a predictable cash flow, growth potential, and will have achieved or nearly achieved profitability.
Investors or Angel Investors Investors or Angels Investors invest in businesses in return for partial ownership or debt repayment. For the most part they do not participate in the management of the business, but do take on a board position. Financing is usually either as equity investment or convertible debt. In general Angel Investors do not do straight loans. Angel Investors, at least the professional ones, do not share in the distribution of earnings, called “draws” in a partnership or “dividends” in a corporation. Angel Investors, for the most part, look for hyper-growth and high potential businesses to invest in (companies that can grow to revenues in the range of $15MM-$20MM in 3-5 years). Furthermore, they look for businesses that have high prospect for an exit (acquisition or IPO).
Venture Capital Venture Capitalists provide equity investments to businesses experiencing rapid growth on average of 50% per year or more and yearly revenues exceeding $25MM. In addition to firm ownership, venture capitalists will also want management input in the form of board seats and may require executive positions in the daily operation of the business.
Mezzanine Financing Mezzanine is a hybrid of debt and equity financing that is typically used to finance the expansion of more mature, existing companies. Mezzanine financing is basically debt capital that gives the lender the rights to convert to an ownership or equity interest in the company if the loan is not paid back in time and in full. It is generally subordinated to debt provided by senior lenders such as banks and venture capital companies. This type of financing is aggressively priced with the lender seeking a return in the 20-30% range.
Asset-Based Lending Asset-based financing is a specialized method of providing structured working capital and term loans that are secured by accounts receivable, inventory, machinery, equipment and/or real estate. This type of funding is great for startup companies, refinancing existing loans, financing growth, mergers and acquisitions. Asset-based lending comes in many flavors. Here are some examples:

  • Assigning short term assets, such as accounts receivable or inventory, to the lender
  • Purchase order financing
  • Factoring where the lender purchases your invoices, holds back a portion of the proceeds for future bad debts, deducts their fees before remittance, and remits a net amount, with the remaining amount to be remitted upon collection of the money owed
Crowdfunding Crowdfunding, also known as crowd financing or crowd sourced capital, is an alternative way to raise capital for a business. It refers to a business selling small amounts of equity to many investors usually via the Internet. There are many web sites that act as the means for private investors and business owners to be introduced. Many of these sites have very specific markets or industries that they serve, such as social media, the arts, sports related products, new inventions, etc.
Crowdsourcing Funding Platforms Crowdsourcing is the practice of obtaining needed services, ideas, content or money by soliciting contributions from a large group of people, and especially from an online community. It is often used to fund-raise startup companies and charities. People cannot invest in crowdsourcing projects to make money. They can only back projects in exchange for a tangible reward or one-of-a-kind experience, like a personal note of thanks, custom T-shirts, dinner with an author, initial production run of a new product or the future access to products or services at a discount.
Peer-to-Peer Lending Peer-to-peer lending (abbreviated frequently as P2P lending) is the practice of lending money to unrelated individuals, or “peers”, without going through a traditional financial intermediary such as a bank or other traditional financial institution. This lending takes place online on peer-to-peer lending companies’ websites using various different lending platforms and credit checking tools.