Without a sizable savings account balance and/or reliable monthly revenue, most small businesses need some sort of funding to operate successfully. According to recent reports, roughly 75% of all small business funding comes from small business loans, business credit cards and business lines of credit.1 While these three methods make up the majority of business capital, you can find other loan options to help run your company. Read our small business funding guide to learn more about financing options for your organization.
What’s the Difference Between Debt Financing and Equity Financing?
Typically, business funding falls into one of two categories: debt financing or equity financing. Debt financing involves borrowing money from a lender and taking on a financial debt, while equity financing includes selling a portion of your company in exchange for capital. Businesses with debt financing agreements are required to repay the money borrowed (plus any interest or fees, per the loan terms), while those with equity financing agreements generally are not required to repay the invested capital.
Equity financing means that a business relinquishes some financial control, and is in partnership (to the extent of the agreement) with another party. Equity financing is considered a long-term financial agreement, as a third party is investing into another business in hopes of receiving a return on the capital. On the other hand, debt financing agreements typically last anywhere from a few months to a few years, depending on the loan term, and businesses maintain full control of their day-to-day activities and finances. Debt financing is generally easier for small businesses to qualify for than equity financing.
How Much Will I Need to Fund My Small Business?
While small business funding needs will vary based on details like your business plan, industry, type of company and specific internal needs, research suggests that the average startup capital amount required for new small businesses is around $10,000, though other reports suggest that amount can reach as high as $80,000 or more, depending on the particular situation.1 For a more in-depth startup estimation, visit the U.S. Small Business Administration startup costs calculator.
Funding needs for established and/or non-startup small businesses will also depend on many factors, like the company’s average revenue, internal expenses, company goals, equipment and/or other considerations.
Debt Financing Options to Fund Your Business
The U.S. Small Business Administration guarantees low-interest loans for small businesses through SBA-approved lenders, though it doesn’t directly fund the loans. This federal guarantee allows direct lenders across the country to provide loans to small businesses that wouldn’t otherwise qualify for funding through other methods, like a bank or credit union.
Paycheck Protection Program (PPP) loans, offered through coronavirus relief packages, are a special form of SBA loan. PPP loans are fully forgivable for businesses that satisfy specific loan requirements, and are available via SBA-approved lenders through March 31, 2021. For more information, head to our PPP loans guide.
Bank Business Loans
Business bank loans are available from brick-and-mortar banks. These types of loans normally feature some of the lowest interest rates for small businesses, though the borrower and application requirements are more stringent. This means that not all companies will qualify for a business bank loan. Furthermore, bank loans require a longer processing period, so approved borrowers generally have to wait longer to access the funds through this method when compared to other funding sources, like online term loans.
Business term loans are available from online lenders and other alternative creditors. Term loans, sometimes referred to as short-term loans or small business loans, are typically funded in one-lump sum for qualified borrowers. These types of business loans are generally easier to qualify for than business bank loans and SBA loans. Due to the reduced processing time, online term loans are generally paid out faster to approved applicants than other forms of financing, like bank business loans.
Business Lines of Credit
A business line of credit is a form of revolving capital that provides reusable access to funds up to the account credit limit. As money is repaid, that amount becomes available for use again without having to re-apply. Business lines of credit are available from sources like banks, credit unions, online lenders and other creditors.
Business Credit Cards
Business credit cards are another common option to help fund your establishment. Credit cards are also considered revolving credit, though lenders typically do not offer as high a credit limit for business credit cards as they do for business lines of credit. Business credit cards are available from a variety of sources, such as banks, credit unions and credit card providers.
Equipment financing loans are designed for the specific purpose of purchasing hardware, machinery and/or gear that’s necessary to help run a business. Generally, the purchased equipment serves as collateral until the end of the loan term. This funding method is available from online lenders and other business creditors.
Invoice financing is a form of business funding that allows companies to borrow money against outstanding, unpaid customer invoices. The borrower is still responsible for the collection of funds from their customers. Invoice financing is available from sources like online business lenders and other alternative creditors.
Like invoice financing, invoice factoring agreements allow businesses to borrow money against unpaid invoices. However, the creditor typically assumes control of the collection process with invoice factoring agreements. This means that invoice factoring can also help small businesses save time, allowing them to focus on other business matters. These types of financial agreements are available from online lenders and other alternative business creditors.
Equity Financing Options to Fund Your Business
Venture funding involves selling a portion or stake of your company in exchange for business capital. Depending on the specific agreement, venture capitalists may have some control and decision-making power in the company. Keep in mind that most venture capitalists tend to work with businesses whom they expect can turn an enormous profit, and there may be a barrier to entry for this reason. Venture funding is available from venture capital firms.
An angel investor, also sometimes referred to as a seed investor, is another form of equity financing for small businesses. Angel investors may be a single person or collection of individuals, in the case of crowdfunding, who have pooled their money in exchange for a share of the respective company. Like venture funding, angel investors generally prefer to work with small businesses that have a good chance of enormous growth or expansion as a result of funding. Small businesses interested in angel investors can look online for angel investor firms, or start a new funding campaign on sites like Kickstarter or Indiegogo.
Common Small Business Funding Questions
How Do Small Business Owners Establish Business Credit?
Small business owners may use personal credit to help start their company or fund new establishments; however, a good business credit score can help your company secure more competitive business financing at a lower rate. Small business loans also typically have a higher principal amount when compared to personal loans, depending on details like the lender and the borrower’s credit history.
A business credit score may be required in order to pursue some types of small business funding. Here’s how to establish business credit for your company:
- Verify that your business’s organizational structure qualifies for the specific type of loan: Ensure that your company has an appropriate business structure for the type of loan you wish to pursue. Some business structures, such as a sole proprietorships and/or nonprofit organizations, may not qualify for all types of business loans.
- Confirm that your company has an employer identification number (EIN): This is a unique numerical identifier similar to a Social Security number, but for businesses. You can apply for an EIN online. Another helpful step is to apply for a Dun & Bradstreet number, also referred to a D-U-N-S Number, though not all forms of business credit require this identifier.
- Publish your business directory: Post your phone number and address online and/or in a business directory to ensure that it’s searchable for business creditors and customers alike.
- Open a business bank account for your company: Make sure to establish a business bank account, not a personal bank account.
- Ensure that your company has an account on file for business credit reporting agencies: These business credit agencies collect payment information in order to quantify an organization’s creditworthiness, or their relative fiscal responsibility. These agencies include Dun & Bradstreet, Experian and Equifax. Make sure that your company’s information on file is accurate and up-to-date.
- Work with other businesses that report payments directly to business credit reporting agencies: Just like your personal credit history, not all companies report payments to credit reporting bureaus. However, this payment information can be used to build a credit history for your company, so your business can show fiscal responsibility through reliable, on-time payments even before getting a business loan. You can ask whether or not your payment information is sent to these agencies before committing to a business deal.
- Make sure to pay all bills on time and in full: Late or missed payments can seriously hurt your business credit score, while responsible payments can help improve your score over time.
Visit our resource page to learn more about building a strong business credit profile.
What Business Funding Method is Right for My Business?
Different types of business financing will have varying application and borrower requirements. In order to pursue the best form of capital for your business, it’s a good idea to research the available options to you. The following questions can help you determine whether a business loan is a good fit for your needs:
- What are the loan application and/or borrower requirements? Find out whether your personal credit and/or your business credit is sufficient for the specific type of funding. Read this guide to learn more about your credit scores.
- What are the repayment requirements? Can your business reasonably afford to repay the loan, according to the credit agreement? Make sure to consider any business expenses, average monthly revenue and/or other costs for the full loan term.
- Does the loan satisfy your business’s financial needs? If the loan principal is too small, a different type of loan and/or another creditor may be able to provide a higher loan amount.
Where Can I Get Free Money For My Small Business?
Unlike loans and other types of business capital, most business grants are considered a financial gift, where funds do not need to be repaid to the originator. Grants are typically given to organizations and businesses in order to help support or promote a particular cause, such as minority-owned companies, technology advancement, renewable resources, urban development and other objectives. They’re available from sources like federal, state and local governments, as well as private donors. Keep in mind that grant funding may be difficult to qualify for, as some programs have very specific requirements.
How Do I Apply for Small Business Grants?
Typically, grants are awarded to companies that work towards a particular goal or objective, as defined by the specific award program. If you wish to pursue a business grant, it’s helpful to start your search online for programs that your company may qualify for. You can also follow up with federal, state and city government offices and/or your local chamber of commerce for information about any available business grants.
1Schmid. G. (2020). Small Business Statistics: 19 Essential Numbers to Know (2021).
The information in this article is provided for educational and informational purposes only, without any express or implied warranty of any kind, including warranties of accuracy, completeness or fitness for any particular purpose. The information in this article is not intended to be and does not constitute financial, legal or any other advice. The information in this article is general in nature and is not specific to you the user or anyone else.