6 Tips for Small-Business Financing

By Ryan Lynch | American Express^® Freelance Contributor
6 Min Read | July 26, 2022

Summary

1. Get Your Financial Ducks in a Row

How much financing do you need? The answer should be fairly straight forward to figure out, assuming you:

• Adhere to a monthly budget.
• Track your business’ finances.
• Understand your current cash flow.
• Have analyzed future business needs and what they’ll cost.

Before parting with a dime, most lenders and financiers will ask to review your business plan to assess the viability and financial health of your business and convince them of your ability to pay back their loan or generate the return on investment they’re expecting. Today, most, if not all, of a business’ bookkeeping can be done using software to track sales, run projections, and produce detailed reports on the state of the business’ current finances.

2. Examine Your Operations

Before seeking external financing, examine your internal workflows and processes to ensure you’re operating as efficiently and, thus, as cost effectively as possible. Tracking and analyzing operational metrics can help you identify areas of wastefulness and work out better ways to operate. By streamlining workflows, you may eliminate the need for outside financing entirely – or at least reduce the amount of debt you require. Lenders are more likely to regard your business as a worthwhile investment, too.

3. Ask for Help

Is taking out a small-business loan your best option? What kinds of loans should you pursue and from where? Government agencies like the Small Business Administration (SBA) and its Small Business Development Centers (SBDCs) have locations all over the country that offer many no-cost or low-cost consultations and training to assist business owners. Banks are another resource, as are people in your network – colleagues, family, and friends – who have taken out business loans in the past.

4. Understand Debt Financing

Debt financing is just a fancy way to say you’re borrowing money from a third party. These loans come in a variety forms, some requiring collateral or a third-party guarantor, and, of course, all including interest in repayment. Sources of external financing include:

• Term business loans: These are issued by traditional lenders, such as a bank or credit union. They include a payoff date and annual percentage rate (APR), which tends to be higher than for personal loans.
• SBA loans: SBA loans are issued through traditional lenders, but they are backed by the government agency, which reduces lender risk. SBA loans can be long-term, short-term, large loans, or microloans.
• Working capital loans: These loans are used to pay a business’ short-term, everyday expenses, such as payroll, utilities, rent, and inventory purchasing.
• Peer-to-peer lending: These loans come from individual investors or businesses that lend each other money, usually through an online third-party platform.
• Business credit lines: Instead of loaning one lump sum of cash that must be repaid, a revolving line of credit provides a business with access to a certain amount of money, which the business can borrow against as needed. You pay interest only on the amount actually borrowed at any given time.

5. Explore Equity Financing

Some small businesses turn to equity financing to meet their needs, especially if they don’t have the credit score or business history needed to get a loan. In equity financing, funds are exchanged for a stake in the company, such as a share of profits or partial ownership. Some common forms of equity financing are:

• Taking on a partner: Partners can come with connections, knowledge, and resources, but they will also get a say in decisions moving forward. Some businesses also partner with vendors in exchange for discounts or exclusivity alongside an investment.
• Venture capitalists: VCs are outside groups of investors that provide funds in exchange for part ownership of a company. They also provide knowledge and connections that can benefit the business.
• Angel investors: Like VCs, angel investors are looking to invest in businesses they think will grow, but they are often wealthy individuals acting on their own. Angel investors may be more willing to invest in smaller or riskier businesses.
• Seed-funding companies: These companies invest money early in exchange for future equity. This is a relatively newer funding model that has grown significantly in the past 20 years.[1]

6. Explore Alternate Financing Methods

According to a 2021 Small Business Trends Alliance survey of over 2,400 small businesses,[2] credit lines and loans, including from the SBA, comprised only 23% of small-business financing. So where else do funds come from? Among the alternative methods :

• Asset-based financing is a type of loan that uses a business’ current assets, such as equipment, real estate, or inventory, as collateral to secure financing.
• Invoice factoring is one way businesses can use their unpaid invoices to generate cash. With invoice factoring, a business sells one or more unpaid customer invoices to a third party, known as a factor. The factor pays the business the majority of the invoice’s value within days and also becomes responsible for collecting full payment from the customer, after which it sends the balance owed to the company less its service fee – typically 5% of the full invoice amount.
• Invoice financing is another way to generate cash from invoices, but in this case the business uses its invoices as collateral to borrow money from a lender. The business, not the lender, is responsible for payment collection; the business is also on the hook to pay interest on the loan and typically a processing fee.
• Rollovers as business startups (ROBS) means a business owner uses retirement funds to pay for startup costs. These can be risky: A business’ failure can lead to a loss of retirement funds and has led to high rates of bankruptcy, according to the IRS.[3]
• Credit cards can be used like a business credit line, and similarly tend to have higher interest rates than traditional loans.
• Overdraft options are often provided by banks for when businesses spend more than is in their accounts. The bank will extend credit to cover the cost, often for a fee, but it can be helpful when working capital is strained.
• Crowdfunding raises money from many people, often through an online platform. Some platforms take a percentage of the money raised or have funding requirements that must be met before cashing out.
• Family and friends can be a cash resource, but be extra sure to put everything in writing to preserve the relationship should a disagreement arise.