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Updated: October 9th, 2023
Building a successful small business requires hard work, an unparalleled amount of determination, and usually some access to capital to invest in business growth. While there are plenty of entrepreneurs getting their ventures off the ground by using personal savings or expanding their operations by reinvesting business profits, the reality is that the majority turn to outside sources of capital to grow their business.
The following guide is a primer on what you need you to know about business financing and an overview of the main options available to small business owners.
Put simply, small business financing is the act of obtaining funds to start or run a business. Small business financing typically falls into two broad categories: debt (various types of small business loans) and equity (money from investors). Your type of business, company size, growth projections, and intended purpose of the loan all ultimately influence what type of financing makes the most sense for your labor of love.
Before digging into the variety of business financing options available, you should take some time to think about why you need additional funds and howyou plan to use the money.
Are you looking for a short-term loan to bridge a cash crunch during a slow season? Or are you looking for something more long-term to invest in big-ticket equipment? Are you considering expanding to a second location? Regardless of what your goal is, having a clear picture of what you want to accomplish, as well as how the investment will impact your bottom line, will help you feel confident you’re making the right choice for your business.
Some of the most popular reasons for seeking small business financing include:
Banks, investors, and lenders want to understand the stability of your operation, your cash flow situation, and how their investment will contribute to the growth of your business.
In exchange for upfront capital, the providers of business financing get a return. In the case of debt financing, the return comes from an interest rate and/or schedule of fees. In the case of equity financing, the return comes from a percentage of ownership in a business. Ultimately, banks, investors, and lenders want to ensure that their investment will help maximize growth for your business.
Some key factors that will most likely be taken into consideration are:
Debt financing involves borrowing money, typically from a traditional bank or alternative lender, with the promise to pay it back with interest over a certain period of time.
Term loan: Like a mortgage or auto loan, a small business loan provides a large lump sum of capital upfront that is paid back in fixed payments over the life (term) of the loan. Payments can be weekly, biweekly, or monthly depending on the lender. Rates typically range from 7 to 30 percent.
Best for: Businesses with a specific purchase in mind who need a larger amount of capital to invest in a growth opportunity.
Equipment financing: Equipment financing is used specifically for purchasing business equipment, which covers items across various industries at multiple price points — everything from bulldozers to point-of-sale systems. Once you finish paying off your loan, the equipment becomes yours — free and clear. Rates typically range from 5 to 30 percent.
Best for: Business owners with less-than-perfect credit that need equipment to maintain or scale their operations.
Business line of credit: A business line of credit allows you to access capital as you need it — you don’t make payments or rack up interest until you actually useyour funds. Most lines of credit are “revolving,” which means your available credit replenishes — after you’ve paid back what you borrowed (plus interest). Rates typically range from 7 to 25 percent — but keep in mind that if your rate is variable, you may end up paying much more than you bargained for.
Best for: Business owners that want fast, flexible short-term financing that can be used to help avoid a cash flow crunch.
Business credit card: A business credit card operates as a revolving line of credit — you have a designated credit limit, and the amount of money available to you depends on how much you spend and subsequently pay off. Like personal credit cards, each month you’re required to make a minimum monthly payment. However, business credit cards offer higher limits than those of personal credit cards. Rates range from 13 to 25 percent, but beware — it’s not enough to think about the initial interest rate alone: you also have to consider variable rates, annual fees, and late payment penalties.
Best for: Businesses with short-term finance needs or small, ongoing working capital expenses. Or new business owners who may not necessarily qualify for a traditional small business loan.
SBA loan: The U.S. Small Business Administration (SBA) offers several types of SBA loans for general or specific business purposes, such as purchasing real estate and equipment or recovering from declared disasters. With low, fixed interest rates starting between 4 to 7 percent, SBA loan terms are hard to beat. However, SBA loans require lengthy paperwork and tend to have much longer approval wait times.
Best for: Businesses with strong credit who have the time and resources to afford a longer application and funding process — expect a timeline of at least 60 to 90 days.
Invoice financing: An invoice financing company lends you cash upfront against your outstanding invoices. Once you receive payment, you pay back the lender the loan plus interest and applicable fees. Factor fees (the rate used to determine applicable fees) range from 8 to 30 percent, but your actual APR can be much higher than that depending on how long your clients take to pay.
Best for: Businesses in need of steady cash flow to keep operations running smoothly.
Merchant cash advance: Merchant cash advances (MCAs) are cash advances against your future earnings. You get a lump sum of capital upfront, which you then pay back with a percentage of your daily credit card sales. The appeal of MCAs is that your daily payment is proportional to your daily sales (the more you sell, the more you pay, and vice versa). This can help you worry less about not making your payment during slower months — however, this payment structure can also lead to really, really (did we say really?) high annual percentage rates. So it’s crucial to the understand the true cost of an MCA before signing on the dotted line.
MCA rates are quoted as factor rates, which usually range from 1.1 to 1.5. You can multiply your loan amount by the factor rate to determine the total amount you’ll owe. So a $100,000 MCA with a factor rate of 1.3 means your total repayment would be $130,000. It’s also important to note the holdback or retrieval rate, which is the the percentage — typically between 8 and 30 percent — of your daily credit card sales that an MCA provider takes until you pay back what you borrowed (plus fees).
Best for: Businesses that have short-term financing needs and require funds fast. Or business owners who are just starting out and may not meet the criteria to qualify for traditional financing options.
Equity financing involves selling ownership, or equity, of the business to investors in exchange for upfront capital. Investors are looking for businesses that will provide a return over time. Equity financing spans a wide range of activities in scale and scope, from a few thousand dollars raised from friends and family to millions from venture capitalists chasing the next Facebook or Uber.
Friends and family: Those who know you best are the most common source of small business equity financing. When you’re a new business, or even just a concept, lenders and independent investors will likely not be willing to take on the risk, but those who are close to you and believe in you might be willing to take a chance on your budding business by investing their personal money. For example, sweetgreen started with a single shop in 2007 that was funded by 40 friends and relatives.
Best for: Entrepreneurs with friends/family who have entrepreneurial experience or other useful know-how, and/or access to capital.
Angel investor: An angel investor is focused on investing his or her personal money (and time!) in the early stages of promising startup companies — sort of like a bridge between friends and family and the more formal venture capital funds. Angel investors often serve as valuable mentors to new businesses, but their involvement also comes with some requirements — including a percentage of your net earnings (assuming your startup becomes profitable) and a hands-on role in determining a future exit strategy.
Best for: Startups with a great team and good market, who also have the potential to return 10 times the investor’s initial investment in a period of 5 years.
Venture capitalists: Venture capitalists, or VCs, invest money from a fund of third party capital, in return for equity. Typically, VCs invest in technology companies that have the potential to scale extremely quickly and offer high returns. So unless your small business is poised to be the next “unicorn,” venture capital is likely a no-go.
Best for: Entrepreneurs with an existing business that is experiencing dramatic growth and in need of millions of dollars to continue on that trajectory.
Besides equity and debt financing, there are two other types of small business financing options.
Crowdfunding: Instead of limiting your business pitch to a few investors, you can choose to fundraise to the whole world through online campaigns on crowdfunding websites. Contributions usually start at $5. However, you can encourage higher contributions by offering special rewards, such as a limited edition versions of your product or unique brand swag.
Best for: Business owners with a large social media following or a compelling story that can resonate with a large audience.
Grants: Unlike equity and debt financing options, small business grants are essentially free money (mostly from government organizations and non-profit organizations) that you don’t have to pay back. Understandably, the competition for small-business grants is fierce, and it takes considerable time and effort to win them. But if you’re up for the challenge, the payoff can be worth it.
Best for: Anybody!
When it comes to debt financing, you should be ready to provide at a bare minimum: a business plan, financial statements for the last three years, projections for the next three to five years, and your personal credit score (and business credit score, if applicable).
When it comes to business financing, Funding Circle stands out for our ease and efficiency. It takes just a few minutes to apply, with a decision from us in as little as 24 hours after document submission.
Funding Circle offers business term loans with repayment terms ranging from 6 months to 5 years and competitive interest rates. We believe in an honest, transparent borrowing experience, so you’ll know exactly how much you have to repay each month — no need to worry about variable interest rates. Plus, unlike some other lenders, we don’t have a prepayment penalty. That means you’re free to pay off your loan as quickly as you’d like!
Why should I borrow from Funding Circle as opposed to a bank or other lender?
+While the underwriting process at traditional banks can be clunky and opaque, Funding Circle delivers a best-in-class experience to our business customers. You’ll work with a dedicated loan specialist who will guide you through the entire application process and remain focused on meeting your unique financing needs. And we will never leave you waiting — you’ll have a decision from us in as little as 24 hours after document submission. We also deliver competitive rates, with no prepayment penalty.
How long does it take to apply for financing through Funding Circle?
+Funding Circle’s application process is quick, easy, and transparent. You can apply for a loan and get your instant quote in just 6 minutes, and have the money in your bank account in as few as 10 days.
Do you offer business financing for startups?
+No. We offer loans to small businesses that have been in business for two years or more.
Paige Smith is a content marketing writer who specializes in writing about the intersection of business, finance, and tech. Paige regularly writes for a number of B2B industry leaders, including fintech companies, small business lenders, and business credit resource sites.