How to Finance Your Small Business: The Four Most Common Ways

By Ryan Smith on May 22, 2018

Asking for money is generally an un-fun activity for 99% of business owners. It’s intimidating. It makes your palms sweaty.

But here’s the thing: there’s lots of people out there who actually want to give you money for your small business (giving you money is how they make money *mind blown*.)

In this article, we’ll walk you through all the available funding options, and which ones are a good fit for your business type.

Option 1: Pitch your business to investors

There are two types of investors that can help with your business funding: angel investors and venture capitalists. Both are great for helping small businesses raise money. But they serve slightly different stages of business.

Here’s how they differ.

The angel investor is like the rich relative every entrepreneur wishes they had.

They typically work with new companies, taking entrepreneurs under their wings and teaching them how to succeed in the business world. They invest in companies for a number of different reasons; some are looking to make money, while others may do it for their own personal enjoyment. For small business owners who could use the guidance of an experienced mentor, this is a solid option.

Venture capital firms are like angel investors with suits and ties.

Venture capitalists are concerned with one thing: results. They prefer to work with companies that already have a track record of success, and usually have a specific timeframe to see returns before they recoup their investment. Venture capital firms typically work with startups who are looking to grow at a fast pace. For small business owners who are playing the long game, this option may not be the best fit.

Instead of lending money for an extended period of time (like a bank), these types of investors give money to your business in exchange for a stake in the company, which is usually expressed as a percentage.

 

 

Option 2: Use a loan to fund your business

Personal and small business loans are two of the most common ways entrepreneurs finance their small businesses. The right option for you depends on a few different things, like whether your business is making money or not.

  1. Small business loans are taken out under your business name (so your personal credit isn’t affected if you default on the loan.) Many are backed by the Small Business Administration (SBA) and offer higher loan limits than personal loans, but have stricter qualifications. We’d recommend this option if you’re looking for a larger loan amount and are concerned about protecting your personal assets.
  2. Personal loans are taken out in your name, meaning you are personally responsible for payments if your business goes under. These are typically easier to attain than SBA loans, and can be used to raise money for businesses that don’t even exist yet. We’d recommend this if you’re a first-time business owner and need financing quickly.

Further reading: Should I Fund My Business With a Business Loan, or a Personal Loan?

Getting an SBA-backed loan

If you’re thinking of getting small business financing with an SBA-backed loan, you’ll need to meet a few qualifications, such as:

Since SBA loans are issued by a private lender, there’s still the off chance of getting rejected after meeting all the government requirements.

The good thing about SBA loans is that they offer “prime plus” interests rates that are lower than traditional loans. They also have longer repayment terms—usually anywhere between five to 25 years.

SBA loans are great for when you need a lot of money. The maximum loan amount on an SBA loan is $5 million, with $3.75 million of that guaranteed by the government.

Getting a personal loan

If you need cash fast, you might opt for a personal loan instead. You’ll get your money much faster than a small business loan (which can take up to three weeks.) In fact, the entire process usually takes as little as one day with a personal loan. Nice, right?

However, there are a couple of downsides.

Along with being personally responsible for repaying your loan, personal loans also have lower limits—usually maxing out around $40,000. Most lenders require a minimum credit score of 600 for these types of loans, but some will accept applicants with FICO scores as low as 580.

Personal loans also differ depending on the lender and your credit history. Borrowers with good credit scores may qualify for an interest rate of 5.99%, but if you’ve got a FICO score in the low 600s, you could pay as much as 36% interest. At that point you might as well be working with a loan shark. (We’re kidding. Please don’t work with a loan shark.)

Option 3: Open a business line of credit

A business line of credit is financing that can be used for a business’s short-term capital needs (like inventory, company payroll, etc.) They’re great for people who don’t like to get locked into the terms and conditions that come with venture capital and bank loans.

Say you get approved for a $100,000 limit and only spend $10,000 of it—you only have to pay back the money you spent. You can’t go beyond your limit without first making payments on what you already spent.

Sound familiar? It works almost the same way that credit cards do.

There are a few differences between credit cards and a business line of credit:

  • With credit cards, you have an option not to pay any interest if you pay back within a certain time frame.
  • Business lines of credit have a much higher limit than most credit cards. Most business credit lines max out at $100,000, but some even go as high as $200,000.
  • You’re expected to pay off your credit line within a specific time frame (usually within a 6 to 12-month period.)

Before getting approved for your business line of credit, there are a few qualifications you need to meet, such as:

  • A credit score of 500 or higher in most cases. Naturally, the higher your FICO score, the better your chances of approval.
  • At least six months of business activity is the norm. To get approved for a six-figure credit limit, you’ll probably need to have operated your business for one or two years.
  • Minimum annual revenue of $25,000.

Business lines of credit are issued by banks and private lenders, so the terms and conditions will vary depending on who’s issuing the money—but these qualifications tend to be the minimum. As a general rule, the more relaxed the qualifications are, the higher your interest rate.

When shopping around for a business line of credit, keep in mind that every lender is different. Some companies may offer you interest rates anywhere from 9–15%. Others charge as much as 78% interest—especially lenders with no minimum credit score. The takeaway: be sure you know the details of your interest rate.

Option 4: Apply for a small business grant

Think of small business grants as scholarships for entrepreneurs.

Grants can be funded privately or sponsored by state and federal governments. Each grant is different and comes with its own unique set of qualifications. Still, all grant programs share one thing in common: you don’t have to pay the money back provided you follow the terms and conditions of the grant.

How to find a grant you qualify for

  • Grants.gov is a database of all public grant programs. If you want to apply for a government grant, this is the first place to start.
  • If you work in research and development, check out Small Business Innovation Research (SBIR) and Small Business Technology Transfer (STTR) programs at SBIR.gov to view federal grants from 12 different government agencies.
  • Visit the State and Territory Business Resources page on USA.gov to look at different state-sponsored grant programs. If your state government offers small business grants, you can find them here.

There are also a number of different private grant programs, many of which are sponsored by corporations like FedEx, Walmart, and Coca-Cola.

For a more comprehensive list of public and private grants, check out this article listing 106 different grants for small businesses.

There’s a solution for everybody

Now that we’ve looked at all the different ways to raise money for your business, let’s recap with some side-by-side comparison.

 

Type of Funding Summary Who’s it best for? Pros Cons
Angel investing Investment money from a private investor, usually someone with interest or experience in your industry. Early-stage businesses interested in investors that play a hands-on mentorship role. The money isn’t a loan. If your investment fails, you won’t have to pay back the funding.

Many angel investors are experienced business professionals happy to provide guidance and support.

Your investor has some control over your company’s future.

Instead of paying the money back, you give away a portion of your future earnings to the investor.

Venture capital investing Investment money from a firm interested in capitalizing off your company’s success and maximizing their ROI. Established businesses with a successful track record. Venture capitalists are able to make generous financial contributions to your company.

You’re more likely to be introduced to other investors to increase your chances of success.

Like angel investors, venture capitalists assume part of your company’s control and future earnings—but at a larger scale.
Business loans A loan designed to help small businesses grow. Taken out under the business’s name. Established businesses with 2+ years of experience. Competitive interest rates, and the qualifications are relatively the same from lender to lender.

Doesn’t affect your personal credit score if the company fails.

Potential for a big loan.

Long waiting periods.

Can be difficult to get accepted. Businesses need to be two years old and have a minimum credit score of 620.

Doesn’t always have cheaper interest rates than personal loans.

Personal loans A standard bank loan is taken out under the individual’s name. New entrepreneurs who don’t yet meet credit score or age requirements.

Business owners with no collateral to leverage.

Businesses who need money fast.

Easy for people just starting a business. Doesn’t require your business to be running for a specific period of time.

Interest rates as low as 5.99% for borrowers with good credit.

Some lenders accept applicants with credit scores below 620.

Loans are approved quicker than business loans.

Lower limits than business loans.

Expensive interest rates for borrowers with low credit scores.

Borrower has to pay back the loan even if the business fails.

Business line of credit A credit line that gives businesses short-term money. Works similar to a credit card. Entrepreneurs who want business funding without being locked into rigid terms and conditions. Only pay back what you actually spend.

Only pay interest on what you owe.

Some lenders approve borrowers with credit scores of 500 or lower.

Depending on your annual revenue and FICO score, you could be stuck with a higher interest rate.

Most lenders require you to be in business anywhere from six months to two years before you can qualify.

Small business grants Free money used to help promote small businesses in various fields. Grants are given by government agencies or private donors. Any small business owner that qualifies for the specific grant. It’s free. You don’t have to pay anything back as long as you use the grant money as it’s intended to be spent. Hard to come across the programs if you don’t actively look for them.

Can be competitive.

Most have very specific requirements.

 

There’s lots of money in the world: yours, and everyone else’s. Now that you know how to get some of the latter, there’s nothing standing between you and your Big Hairy Audacious Goal.

And if you need bookkeeping for all the new business you’re about to bring in, Bench can help with that.

 

This post is to be used for informational purposes only and does not constitute legal, business, or tax advice. Each person should consult his or her own attorney, business advisor, or tax advisor with respect to matters referenced in this post. Bench assumes no liability for actions taken in reliance upon the information contained herein.

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Ryan Smith

Ryan writes for Bench, the online bookkeeping service that does your bookkeeping for you.