When you are in business eventually you are going to need money. Finding the best funding sources for your small business depends upon many factors. Often times, the key to determining the right capital source depends which stage of growth your business is in. As you move from start up to expansion, your small business financing needs and the funding sources available to you change.
The road to small business financing is not linear—businesses often find themselves accessing multiple sources of capital in each business phase. For example, a newer business can borrow from friends and family, as well as obtain U.S. Small Business Administration (SBA) backed financing. An established business (someone in business 2-years or more) can go through a period of growth and want to turn to banks or investors.
Here are some of the most common financing options in each business phase.
In the startup stage, your capital might come from SBA micro loan programs, community lenders, and other non-profit loan programs. However, equity is often a funding source for businesses in an early stage. Equity should be viewed as a long term investment in your company that does not bear interest and generally does not have a specified repayment schedule. Equity sources include:
- Personal savings
- Family or friends
- Angel investors or venture capitalists (usually for high growth potential businesses like technology companies)
Pros: Low cash outlay (e.g. no interest or repayment), flexibility in use, ability to plan for long term growth.
Cons: Pressure on your personal savings, collateral is often required, puts stress on family/friend relationships, loss of full ownership of your business, if using angel investors or venture capitalists.
Once your business is established, you will undoubtedly need capital to increase production, expand your team, add a second location or even make an acquisition. The problem for many small business owners is you may not be eligible for a traditional bank loan because you do not have a track record, you have credit challenges or you are in a high-risk industry. There are a large number of alternative non-bank lenders willing to provide you capital. The bad news is that not all of these lenders are affordable or have transparent terms.
Many alternative lending companies offer loans for early stage small businesses in need of quick access to capital. These lenders rely on your incoming revenues, debit/credit card receipts and/or the collection of receivables for the repayment of their loan. They can charge extremely high interest rates and fees and may not follow the same disclosure rules to consumers as banks. Some of these alternative financing products include:
- Factoring of customer accounts receivables
- Merchant cash advances
- Online loans
Pros: Quick approval/processing time, lower credit standards, quick access to funds.
Cons: High interest cost & fees (annual percentage rates (APRs) can be 30% to 80%), daily/weekly automated debit repayment, short repayment term, lack of clear disclosures on costs/fees.
Look for lenders or brokers who offer loan terms up front, have a physical address, and display website security disclosures on web pages. We also encourage you uncover the true cost of different loan types by calculating the APR for each option and consider the repayment terms:
- Merchant cash advances can have the highest APRs and repayment is generally daily or weekly
- Online term loans can also have very high APRs and repayment terms may vary from daily to weekly or monthly
- Be sure to research whether there are prepayment penalties.
Looking at all these factors will give you an apples-to-apples comparison of your options. You might be surprised to learn of the “true” cost of different small business loans.
Community Development Financial Institutions (CDFIs): Another option for financing is mission-driven alternative community lenders. Community Development Financial Institutions (“CDFIs”) These CDFI organizations are generally non-profit lenders, certified by the U.S. Department of the Treasury. Many provide small business loans and have a mission to provide financing to businesses unable to access traditional financing.
Pros: Flexible loan products/underwriting criteria, more affordable than other alternative lenders, longer repayment terms available, many offer advisory services as well
Cons: Many focus on smaller dollar lending, wide range of processing time, and collateral is required
The SBA also has programs to facilitate small business lending. Participating lenders offer these loans with support or guarantees from the SBA. These programs include:
Microloan Program: Typically under $50,000, this type of loan can be used for working capital or to purchase inventory, supplies, or equipment.
Pros: Flexible terms tailored to meet small business needs, more flexible underwriting criteria, interest rates below ‘typical’ alternative products, longer repayment terms, and advisory services.
Cons: Small average loan size, slower loan processing time, collateral is required, if available.
7(a) general small business loans : Formally called the 7(a) loan, this is the most common type of SBA term loan suitable for most businesses. It can be used for a variety of purposes, such as working capital, equipment, refinancing debt, etc. SBA Community Advantage Loans are similar to the SBA 7(a) loan and designed to help underserved communities get access to funding for working capital, equipment, refinancing debt, etc.
504 loans : This type of SBA term loan can be used to purchase real estate and equipment and to modernize or renovate business space at very affordable rates.
CAPLines loans : Lines of credit used to help businesses meet short-term and seasonal working capital needs and fulfill contracts and purchase orders.
Pros: Interest rates lower than other alternative loan products, longer repayment terms, and start-ups are eligible.
Cons: More detailed loan documentation, long loan approval process.
Established – Expansion Stage
Once your business is mature and you have reached the established-expansion phase of growth, your small business is likely on solid ground with predictable revenues and cash flow! Now you can apply for traditional loan products with the most attractive interest rates and terms. At this stage in your business, you will likely qualify for a loan offered by conventional banks. Of course, if you can get bank financing earlier on in your business life cycle, you should do that, too! When seeking capital, consider refinancing any existing higher interest rate debt or get ready to fund your next growth plan. Traditional bank loan products include:
- Secured and unsecured lines of credit, used primarily for short term working capital purposes
- Term loans, used to fund expansion or the purchase of longer term assets such as equipment & machinery
- Commercial real estate mortgages, used to purchase buildings & property
Pros: Low interest rates, various products and repayment terms, lend on cash flow or collateral.
Cons: Requires stronger personal credit scores, business track record, and historical cash flow.
There are many choices when seeking capital. If you are a small business owner who needs help navigating funding sources, there are many organizations out there to assist you.
The SBA has many counseling and educational services, most of which are offered at no cost. SCORE is a nonprofit organization sponsored by the SBA that offers free counseling, advice and information on starting a business. There are approximately 348 SCORE chapters across the United States. Free advisory services are also available through the network of Small Business Development Centers (SBDCs). SBDC advisors provide free business consulting in the following areas: business plan development, manufacturing assistance, financing packaging and lending assistance, exporting and importing, disaster recovery assistance, procurement and contracting aid, market research help, 8(a) program support, and healthcare guidance. Women’s Business Centers (WBDCs) assist women in starting and growing their small business through comprehensive training and counseling on a variety of topics. There are nearly 100 centers throughout the United States.
About the author
Steven Cohen is president of Excelsior Growth Fund (EGF), a nonprofit small business lender and business advisory service provider, certified by U.S. Treasury as a Community Development Financial Institution (CDFI).