Viable small business financing options continue to expand.
Businesses rely on a variety of funding sources for their initial launch, growth, and ongoing operations to sustain their activities and expand their market presence. Small businesses are no exception, as sole proprietors, entrepreneurs, and LLCs leverage their available options. The financing avenues for smaller companies differ significantly from large corporations, but there are still many viable alternatives available to small business owners.
In this blog post, we look at some of the more popular small business funding options, review their pros and cons, and explain the circumstances where each approach becomes a prudent choice for private business financing.
Types of financing
Most business funding methods can be classified as either debt or equity. With equity financing, a portion of the business’s future value (ownership) is exchanged for funding dollars, whereas debt financing includes loans from private lenders, credit lines, and bank loans. Debt and equity are not mutually exclusive, as many small businesses choose a balanced combination of both for their funding.
Both general funding categories have inherent advantages and drawbacks. Business loans can provide quick access to cash and fixed monthly payments that allow business owners to remain in full control of operations. However, loans and interest repayment can also become an expensive burden, especially when cash flow is strained, or interest rates are high.
Equity financing offers the advantages of cash infusion with no financial impact for months or years, along with potential mentorship and guidance provided by an experienced partner. Equity investments also lack the potential loan guarantees and collateral requirements that often accompany debt financing. On the other hand, equity financing usually requires owners to cede some level of business control and decision making power to the investors, along with a portion of ownership in their company.
6 small business funding options
As you learn how to finance a small business, you may discover that the list of alternatives has grown longer in the digital age. Reviewing the pros and cons of each option is one of the best ways to decide what best suits your unique business and circumstances.
1. Bank loans
Business loans have expanded beyond traditional brick-and-mortar banks to include a variety of online options tailored to specific business needs. Loans from established banks and credit unions can be a reliable source of low-interest funding for businesses demonstrating consistent cash flow. However, with big banks approving only 66% of business loan applications, not all businesses can qualify for this type of funding.
- Bank loan pros: Long terms, low interest rates, flexible use, established relationships.
- Bank loan cons: Strict eligibility requirements, long waiting times, need for collateral.
Given these constraints, traditional bank loans can be a great option for established small businesses that are already generating sales, rather than new companies or startups seeking funding for their initial launch.
2. SBA loans
This category of business loan is partially guaranteed by the U.S. Small Business Administration (SBA), a government agency formed to help small business owners. The loans are issued by qualified lenders, rather than the SBA itself. The SBA 7(a) loan is a popular option sought out by business owners to refinance debt or provide short-term working capital.
- SBA loan pros: Government backing, high dollar amounts, low interest rates.
- SBA loan cons: Long approval process, additional paperwork, strict requirements.
For businesses with the time and resources available to complete the more stringent application process, SBA loans can provide high-dollar infusion with generous long-term repayment options.
3. Lines of credit
A revolving business line of credit is a flexible option offered by both online and brick-and-mortar lenders. Credit lines allow the borrower to draw down the available funds when they need them, then secure additional funds from the available pool without applying for a new loan.
- Line of credit pros: Quick funding, only pay interest on what you use, ability to re-borrow funds.
- Line of credit cons: High interest rates, continuous debt cycle, additional fees.
A small business line of credit can be a good choice for businesses that need flexible, short-term access to funds to manage cash flow fluctuations or cover unexpected expenses without the burden of a lump-sum loan.
4. Grants
For business owners who want to explore how to finance a business without assuming business debt or giving up equity, small business grants can be a great option. There are many grants available through federal, state, and local government agencies that provide financial assistance to small businesses in industries like healthcare, technology, education, and sustainable energy.
- Grant pros: No repayment obligation, no dilution, builds business credibility.
- Grant cons: Lengthy application process, competition, not available to all business types.
Business owners focused on innovative products that demonstrate a positive social or environmental impact may have the most success leveraging grants to help fund and expand their business.
5. Crowdfunding
Over $17 billion is generated yearly through crowdfunding in North America, making it one of the fastest-growing small business funding options. Crowdfunding involves raising small amounts of financial capital from a large number of people, usually through online platforms, to finance a new business venture or product idea.
- Crowdfunding pros: Builds an audience, tests viability, low financial risk.
- Crowdfunding cons: Platform fees, uncertainty, all-or-nothing models.
Crowdfunding is a great option for companies looking to build a loyal customer following early on and raise funds without taking on debt or giving up equity. Companies with eye-catching products and well-crafted elevator pitches find it easier to stand out in the sea of crowdfunding competition.
6. VC and angel investors
Small business funding options involving equity often come in the form of venture capital (VC) or angel investors. While angel investors are typically high-worth individuals who invest passively in novel companies early on, venture capital firms may take a more active role such as seeking a seat on the board of directors.
- VC and angel investor pros: Access to large amounts of capital, business mentorship, increased credibility.
- VC and angel investor cons: Dilution of ownership, pressure to perform, loss of business control.
Venture capital and angel investors are a great option for startup companies with new and unique technology, or fast growing businesses that can afford to trade their future equity for debt-free financing.
7. Private equity
Similar to venture capital, private equity provides capital in exchange for a percentage of ownership. However, PE firms often raise funding to purchase a business outright or buy a majority stake that is accompanied by strategic control of major business decisions.
- Private equity pros: Operational expertise, substantial capital, networking, focus on growth.
- Private equity cons: Rigorous due diligence processes, management culture clashes, focus on exit strategies.
Private equity might be the best option for companies looking to scale their proven business rapidly. It’s particularly suited for businesses that are open to ceding some control in exchange for strategic guidance and industry connections.
In conclusion
Small businesses have a variety of funding options to consider, each with its own set of advantages and challenges. Financing decisions should be given the time and consideration they deserve, based on their long-term impact on valuation, cashflow, and growth. As you decide how to finance your business, peeling back the layers of equity and debt financing options will help you align your funding sources with the specific needs and growth stage of your business.