You started with inspiration. You’ve done the market research to get to know your potential customers and established your advantage over competitors. You’ve written your business plan so you know where you’re headed. Now it’s time to figure your startup costs and decide from where you’re going to source the funds.
This is a big step where many businesses lose traction. And the challenge won’t end here. Nine out of ten startup companies fail, with 21.5 percent going out of business in the first year. However, you should also know that the nation’s 31.7 million small businesses make up 99.9 percent of U.S. businesses — it is entrepreneurs like yourself that fuel the economy. Rather than allowing failure rates to discourage you, ensure you have a competitive advantage.
That includes securing enough funding to keep your business afloat at first. Many businesses fail because they run out of funding before they become profitable. Once you have an estimate of your expenses, you can pull funding from any of the following sources.
12 Sources of Funding for Small Businesses
(Note SB programs are subject to change.)
Personal Savings
About two-thirds of new business owners used their own savings to start their company and about 27 percent used income from a second job, so it’s not uncommon to rely on your own savings in the beginning. However, you should leave your emergency fund intact. If your business fails, you’ll still want to be able to provide for yourself and your family until you can find other income. You’ll also need cash in the bank for the early months when your business isn’t yet profitable.
But depending on your business needs, you may not need as much in savings as you think. 42 percent of businesses started with less than $5,000 in cash reserves. Still, this likely won’t be your only source of funding.
Friends and Family
Many small business owners get support from friends and family — one survey found that half of entrepreneurs rely on those closest to them for funding. If you’re going to go this route, you should understand the tax consequences. You can get up to $15,000 in gift money from each friend or family member before they’ll have to pay gift tax. But a better option is probably to enter into a legal loan agreement with each friend or family member who agrees to help. They’ll need to charge you at least the Applicable Federal Rate, which is the minimum amount of interest that can be charged on a loan, as directed by the Internal Revenue Service.
Traditional Small Business Loans
You may be able to get a small business loan from a bank, credit union, or online lender if both your personal and business credit score are in good standing and you have a well-developed business plan and expense sheet. The following types of loans may be available to you:
- Business term loan: Borrow between $5,000 and $2 million in a lump sum with a term of one to five years and a fixed interest rate
- Business line of credit: A revolving credit line between $1,000 and $500,000 that you can tap at any time for business expenses. These tend to have looser credit standards than other types of small business loans.
- Short-term loans: Known for quick approval and funding, these loans go up to $500,000 and generally need to be repaid in one to three years.
- Merchant cash advance: These lump sum loans are repaid out of your future earnings, usually as a percentage of your credit card deposits. It’s much easier to qualify for than other types of small business loans, but also comes with higher interest rates.
SBA-Guaranteed Loans
The Small Business Administration agrees to guarantee some loans, which means the lender takes on a lower risk when issuing the loan. As such, these loans are often easier to qualify for. You can use Lender Match to find lenders who issue SBA-backed loans.
Most businesses qualify for the SBA’s popular 7(a) loans, but there are some exclusions, such as lending and investing in startups. Decide which of the following loans best suit your needs and apply:
- Standard 7(a) loan: Capped at $5 million, the SBA guarantees 85 percent of the loan amount up to $150,000 and 75 percent of the loan amount if it is greater than $150,000
- 7(a) small loan: These are essentially the same as the standard loans, but the maximum amount is $350,000
- SBA Express: For business owners who need a loan fast, SBA Express loans can deliver the funds within 36 hours. However, the SBA only guarantees half the loan and amounts only go up to $350,00. These loans can also serve as a revolving credit line.
- Export Express: These loans are targeted towards exporters and provide up to $500,000 in funding within 24 hours
- Export Working Capital: The SBA will guarantee 90% of these loans up to $5 million. They’re designed to provide working capital for export sales.
- International Trade: Designed for businesses that are growing due to export sales or evolving due to foreign competition, these long-term loans last 10-25 years
- Veterans Advantage: These loans come with a low APR and are only offered to businesses that are 51 percent veteran-owned
- CAPLines: These are similar to standard 7(a) loans but are catered towards ongoing expenses rather than startup costs, since they offer an ongoing credit line
Business Credit Cards
If you have good credit, a business credit card can provide some excellent perks and rewards while helping to organize your expenses and allowing you to get employee cards as well. But this shouldn’t be the only source of funding for your business. Business credit cards generally come with double-digit interest rates, although some issuers offer an introductory zero percent APR period. Look for cards with rewards that align with your spending needs. For example, if you’re going to be purchasing office supplies, look for a card with good cash back earnings in that category.
Venture Capital and Angel Investors
Individual investors, known as angel investors, and venture capital firms lend money to startups in exchange for equity in the company or partial ownership. There are several investor matching websites you can use to find angel investors, or you can research firms that have experience in your industry. Make sure the investor is reputable and has a track record of investing in startups. To get this type of funding, you’ll need a great business plan and a qualified team, which the investor or firm will review prior to working out the terms of the investment. Once you’ve signed an agreement, you’ll typically get money in rounds, with more money available once you meet certain goals.
Crowdfunding
Crowdfunding is the process of collecting funds from a large number of contributors, typically via an online platform. Crowdfunding often works well for businesses selling physical products, because contributors expect some sort of gift or perk (often the product itself) in exchange for their contribution.
Since crowdfunders aren’t investors, there’s no requirement that you pay them or even make good on your gift promise if your business fails. Crowdfunding is therefore a low-risk way to get funds for your business without giving up equity.
Every platform works differently, but you’ll typically set a fundraising goal for the campaign. If you don’t reach the goal by your deadline, you don’t get any of the money. If you do reach your goal, the crowdfunding platform will often take a cut of your earnings. But you’ll then be free to use the money as you see fit to grow your business.
Peer-to-Peer Loans
With P2P lending, you borrow from an individual or group of investors via an online platform. Each platform has different rates and terms for its loans, but you’ll typically get the money in a lump sum and repay the investor with interest in installments, just like a small business loan. Every P2P lending platform has different credit requirements, maximum loan amounts, fees, and rules, so be sure to do your research before choosing the one that’s right for you.
Corporate Incubators
Some medium-size to large businesses offer assistance to startups, either in the form of capital, training and mentorship, facilities, or some combination. These corporate programs often focus on helping business owners from underserved communities, and they often provide value far beyond funding. With the support of a more established business, your venture might have a better chance of success. You can use the directory or search engine from the National Business Incubation Association to find programs you’re eligible to apply for.
SBA Investment Programs
The SBA regulates and guarantees privately owned investment funds known as Small Business Investment Companies (SBICs). These companies invest in small businesses and their investments are matched at a 2:1 ratio by the SBA. These are typically larger loans ranging from $100,000 to $10 million. The SBIC might charge you interest, arrange for equity in your business, or offer some combination of both.
However, you might be required to surrender control of your business in exchange for SBIC funding. The SBA allows for SBICs to exert control over a business for up to seven years, or longer with SBA approval. It may be direct or indirect, and could look different depending on the companies involved, but you should know what you’re getting into ahead of time.
Grants
Nonprofits, corporations, and governments make grants to small businesses, and this is funding that does not need to be repaid. Aside from the many COVID-19 related grants that are now available for businesses, there are also grants targeted towards women or minority-owned businesses, as well as general startup grants that many businesses would be eligible for. More than 1,000 federal grants are available from Grants.gov, and you can research local nonprofits as well.
Rollovers as Business Startups (ROBS)
ROBS are a way for you to access your retirement funds to start your business without incurring tax penalties. The IRS publishes guidelines regarding rollover as business start-ups. Here’s generally how they work:
- The entrepreneur sets up a shell corporation with a retirement plan
- The plan allows participants to invest everything in their accounts in employer stock
- The entrepreneur becomes the only plan participant and only employee
- The entrepreneur initiates a rollover of funds from their previous qualified plan or individual retirement account to the new plan
- The entrepreneur uses the new account to invest in employer stock
- The entrepreneur uses the funds for startup costs
ROBS can be complex to establish, so consult your accountant or find a free business counselor to make sure you don’t end up with a tax bill after all.
The Bottom Line
It’s likely that the funding from your business will come from a variety of sources. You might start with your own personal savings and family contributions and run a crowdfunding campaign while you apply for grants and SBA-backed loans. Or you might go directly to an investor if you think you have an idea that will grab their attention.
No matter where you get funding, however, it’s important to ensure you have your personal finances operating smoothly before you start a business. You should have a stocked emergency fund, be free of non-mortgage debt, and improve your credit score as much as possible before you start looking for funding. You’ll also need to have a detailed business plan and final projections ready to go.
The information contained herein is provided for free and is to be used for educational and informational purposes only. Consult a financial professional for specific help with your situation.