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agosto 12, 2019

4 Short-Term Financing Options for Small Businesses

Rodika Tollefson

Freelance writer and journalist

Summary

Whether you're growing your business or just starting out, short-term financing options can help with working capital management. Here are some of the options available for small businesses.

When you're growing your business and want to ramp up production, purchase extra inventory or boost your marketing, you likely need an infusion of capital. Even with good working capital management and positive cash flow for everyday expenses, growth often requires additional financing.

Small businesses have access to a variety of short-term finance options, each with its own benefits and potential drawbacks. Your business type, size and maturity are some of the criteria that impact your financing options.

1. Equity Financing

Angel investors, venture capital and even family-and-friends investments are different forms of equity financing. Typically, you're giving up some interest in your company, usually part of the ownership. Angel investments and venture capital are typical for startups because they're not established enough to pursue more traditional short-term finance, like a bank loan.

“Most investors are skeptical looking at a company in a very early startup stage, but venture capitalists will take that risk," says Wahid Choudhury, senior manager with Sensiba San Filippo LLP, a Pleasanton, California-based firm of certified public accountants and business advisors. “They look at the business plan to make sure it's feasible, and if it works out, they take a big chunk of the business ownership."

For a more mature business, equity partnership is a similar option, giving the funder an ownership interest and some decision-making control. But it's typical for equity partners to want to take the company public or sell to another company at a higher price, Choudhury notes.

“For a small business that does not want its ownership or authority of decision-making diluted, they may want to go outside for financing," he says.

2. Business Line of Credit

A line of credit with a financial institution is a good way for a seasonal businesses to access capital on a revolving basis. Terms are similar to a loan, but you only pay interest on the amount you borrow. And just like a credit card, once you repay, you can borrow again up to your credit limit.

Choudhury says a line of credit typically involves some sort of guarantee. This could be the owner's home or other property, inventory, business facility, accounts receivables or the owner's guarantee (if the owner has a good personal credit history).

“If you're a cyclical business and you know that you come to a boom and bust period during the year, you've got to be prepared for that bust period," he says. “Having a good, solid line of credit is a backup plan for a business so that it can maintain continuity during cash-flow issues."

GreenPal—a tech company headquartered in Nashville, Tennessee—used a line of credit while getting off the ground two years ago. Co-founder Zach Hendrix says numerous venture capitalists turned down the pitch, so he took advantage of his high personal credit score to obtain an unsecured $85,000 line of credit for the company.

“We dipped into the entire credit limit through three cash advances to get us through the first year," he says. “We paid it off in the second year and this year, we're going to surpass $3 million in annual revenue. Good thing early investors turned us down because with their capital, they would have owned and controlled 30 percent of our business."

3. Business Credit Cards

Business credit cards are, essentially, a form of line of credit, but often have higher interest rates. Some, however, offer benefits like travel perks and various tools.

Kamil Faizi, owner of Challenge Coins 4 U, based in Cheyenne, Wyoming, obtained a business credit card when he launched the business in 2013 and says it's been “fantastic for everyday things." At the time, the business was too new and he couldn't get a loan—so he used the card for marketing to grow the company.

“I also had a personal credit card but I didn't use it that much because [my business credit card] gave me access to a lot of business tools to help me grow my business as well," he says.

4. Bank and Small Business Administration Loans

Loans backed by the Small Business Administration (SBA) have lower interest rates, but typically have a lot of conditions attached. They also entail more paperwork and consequently take longer to obtain.

When he needed money recently to expand the business, Faizi considered an SBA loan, as well as crowdfunding and investor-backed loans. The company, which sells military challenge coins as well as commercial promotional products, currently has eight employees and is ramping up for growth.

Having a good, solid line of credit is a backup plan for a business so that it can maintain continuity during cash-flow issues.

—Wahid Choudhury, senior manager, Sensiba San Filippo LLP

“We realized that because we were offering more products and wanted to be found online better, we needed to expand, and I also needed money for payroll," he says.

While SBA terms were favorable, Faizi found that the process would be too slow for his needs. Instead, he used an online platform to compare terms from different banks for a $100,000 loan. Having good credit scores, both personal and business, allowed him to get a very low interest rate as well to negotiate the fees.

“My rate is 5.3% but if my credit score was a lot lower, I would be paying 24-25% or more," he says. “People don't realize that there's a huge difference in interest."

Other Finance Options

Crowdfunding has become popular, especially for new businesses, though it works best if you have a new product. Other overlooked short-term finance options are “net 30" terms with vendors and suppliers.

“In some sense, that's the same as borrowing, but without having any interest on it," Choudhury says.

He advises businesses to negotiate terms with their buyers, vendors and suppliers—as well as with banks or other lenders.

“I would negotiate every step of the way," he says. “Sometimes you don't have an option to negotiate with one vendor or one bank, but make sure you have more options available. Everything comes down to analyzing and negotiating."

What to Consider Before Financing

Faizi advises new small-business owners to start building business credit early on, as well as work on improving their personal credit score.

“In the beginning, the bank looks first at your personal credit score and that becomes the primary factor that determines everything," he says. “And then, of course, it becomes easier to get a business loan once you're more established and you can show your income statements."

David Chie, CEO of Palo Alto Staffing based in Silicon Valley and a part-time angel investor, agrees. His company has high working capital requirements, and he's had experience with factoring, asset-based loans, bank credit lines and business credit cards.

“Most financing options as a small business are going to require you to guarantee with your personal credit," he says. “So you really need to know that you're going to be able to produce the results to service the debt and be profitable."

He says one mistake business owners make is borrowing money to finance a lifestyle rather than to make money. He suggests trying to get the minimum repayment as low as possible with no penalty to pay it back faster. That prevents you from overcommiting your cash.

“Borrow for growth," he says. “Understand the true cost [of debt]—and don't overcommit your cash flow."

Photo: Getty Images

The information contained herein is for generalized informational and educational purposes only and does not constitute investment, financial, tax, legal or other professional advice on any subject matter. THIS IS NOT A SUBSTITUTE FOR PROFESSIONAL BUSINESS ADVICE. Therefore, seek such advice in connection with any specific situation, as necessary. The views and opinions of third parties expressed herein represent the opinion of the author, speaker or participant (as the case may be) and do not necessarily represent the views, opinions and/or judgments of American Express Company or any of its affiliates, subsidiaries or divisions. American Express makes no representation as to, and is not responsible for, the accuracy, timeliness, completeness or reliability of any such opinion, advice or statement made herein. 

When you're growing your business and want to ramp up production, purchase extra inventory or boost your marketing, you likely need an infusion of capital. Even with good working capital management and positive cash flow for everyday expenses, growth often requires additional financing.

Small businesses have access to a variety of short-term finance options, each with its own benefits and potential drawbacks. Your business type, size and maturity are some of the criteria that impact your financing options.

1. Equity Financing

Angel investors, venture capital and even family-and-friends investments are different forms of equity financing. Typically, you're giving up some interest in your company, usually part of the ownership. Angel investments and venture capital are typical for startups because they're not established enough to pursue more traditional short-term finance, like a bank loan.

“Most investors are skeptical looking at a company in a very early startup stage, but venture capitalists will take that risk," says Wahid Choudhury, senior manager with Sensiba San Filippo LLP, a Pleasanton, California-based firm of certified public accountants and business advisors. “They look at the business plan to make sure it's feasible, and if it works out, they take a big chunk of the business ownership."

For a more mature business, equity partnership is a similar option, giving the funder an ownership interest and some decision-making control. But it's typical for equity partners to want to take the company public or sell to another company at a higher price, Choudhury notes.

“For a small business that does not want its ownership or authority of decision-making diluted, they may want to go outside for financing," he says.

2. Business Line of Credit

A line of credit with a financial institution is a good way for a seasonal businesses to access capital on a revolving basis. Terms are similar to a loan, but you only pay interest on the amount you borrow. And just like a credit card, once you repay, you can borrow again up to your credit limit.

Choudhury says a line of credit typically involves some sort of guarantee. This could be the owner's home or other property, inventory, business facility, accounts receivables or the owner's guarantee (if the owner has a good personal credit history).

“If you're a cyclical business and you know that you come to a boom and bust period during the year, you've got to be prepared for that bust period," he says. “Having a good, solid line of credit is a backup plan for a business so that it can maintain continuity during cash-flow issues."

GreenPal—a tech company headquartered in Nashville, Tennessee—used a line of credit while getting off the ground two years ago. Co-founder Zach Hendrix says numerous venture capitalists turned down the pitch, so he took advantage of his high personal credit score to obtain an unsecured $85,000 line of credit for the company.

“We dipped into the entire credit limit through three cash advances to get us through the first year," he says. “We paid it off in the second year and this year, we're going to surpass $3 million in annual revenue. Good thing early investors turned us down because with their capital, they would have owned and controlled 30 percent of our business."

3. Business Credit Cards

Business credit cards are, essentially, a form of line of credit, but often have higher interest rates. Some, however, offer benefits like travel perks and various tools.

Kamil Faizi, owner of Challenge Coins 4 U, based in Cheyenne, Wyoming, obtained a business credit card when he launched the business in 2013 and says it's been “fantastic for everyday things." At the time, the business was too new and he couldn't get a loan—so he used the card for marketing to grow the company.

“I also had a personal credit card but I didn't use it that much because [my business credit card] gave me access to a lot of business tools to help me grow my business as well," he says.

4. Bank and Small Business Administration Loans

Loans backed by the Small Business Administration (SBA) have lower interest rates, but typically have a lot of conditions attached. They also entail more paperwork and consequently take longer to obtain.

When he needed money recently to expand the business, Faizi considered an SBA loan, as well as crowdfunding and investor-backed loans. The company, which sells military challenge coins as well as commercial promotional products, currently has eight employees and is ramping up for growth.

Having a good, solid line of credit is a backup plan for a business so that it can maintain continuity during cash-flow issues.

—Wahid Choudhury, senior manager, Sensiba San Filippo LLP

“We realized that because we were offering more products and wanted to be found online better, we needed to expand, and I also needed money for payroll," he says.

While SBA terms were favorable, Faizi found that the process would be too slow for his needs. Instead, he used an online platform to compare terms from different banks for a $100,000 loan. Having good credit scores, both personal and business, allowed him to get a very low interest rate as well to negotiate the fees.

“My rate is 5.3% but if my credit score was a lot lower, I would be paying 24-25% or more," he says. “People don't realize that there's a huge difference in interest."

Other Finance Options

Crowdfunding has become popular, especially for new businesses, though it works best if you have a new product. Other overlooked short-term finance options are “net 30" terms with vendors and suppliers.

“In some sense, that's the same as borrowing, but without having any interest on it," Choudhury says.

He advises businesses to negotiate terms with their buyers, vendors and suppliers—as well as with banks or other lenders.

“I would negotiate every step of the way," he says. “Sometimes you don't have an option to negotiate with one vendor or one bank, but make sure you have more options available. Everything comes down to analyzing and negotiating."

What to Consider Before Financing

Faizi advises new small-business owners to start building business credit early on, as well as work on improving their personal credit score.

“In the beginning, the bank looks first at your personal credit score and that becomes the primary factor that determines everything," he says. “And then, of course, it becomes easier to get a business loan once you're more established and you can show your income statements."

David Chie, CEO of Palo Alto Staffing based in Silicon Valley and a part-time angel investor, agrees. His company has high working capital requirements, and he's had experience with factoring, asset-based loans, bank credit lines and business credit cards.

“Most financing options as a small business are going to require you to guarantee with your personal credit," he says. “So you really need to know that you're going to be able to produce the results to service the debt and be profitable."

He says one mistake business owners make is borrowing money to finance a lifestyle rather than to make money. He suggests trying to get the minimum repayment as low as possible with no penalty to pay it back faster. That prevents you from overcommiting your cash.

“Borrow for growth," he says. “Understand the true cost [of debt]—and don't overcommit your cash flow."

Photo: Getty Images

The information contained herein is for generalized informational and educational purposes only and does not constitute investment, financial, tax, legal or other professional advice on any subject matter. THIS IS NOT A SUBSTITUTE FOR PROFESSIONAL BUSINESS ADVICE. Therefore, seek such advice in connection with any specific situation, as necessary. The views and opinions of third parties expressed herein represent the opinion of the author, speaker or participant (as the case may be) and do not necessarily represent the views, opinions and/or judgments of American Express Company or any of its affiliates, subsidiaries or divisions. American Express makes no representation as to, and is not responsible for, the accuracy, timeliness, completeness or reliability of any such opinion, advice or statement made herein.