How to Get Funding to Grow a Business
There are countless ways small businesses can access capital to expand operations. Some may be better for you than others. Here’s an overview of some popular options, along with pros and cons of each. Be sure to keep in mind that anytime you are considering financial decisions for your business, you should consult with your financial advisor.
Many people who start and expand businesses use their own money to do so. It can be a big sacrifice to save up enough to invest in a business, but it can be worth it to have your dream business become a reality.
Pro: Savings could be a great source of financing, if you can afford it. It keeps you in complete control over your operation and how you run it. You never have to justify anything you do to outside investors or lenders, except possibly your spouse or partner if you’re using joint savings. Plus, you get to keep all the profits.
Con: You risk losing your savings if your business is unsuccessful. Carefully consider whether you can afford to lose the money you invest in your operation or if it will lead to unacceptable hardship if you did.
Many entrepreneurs use their credit cards, or the equity in their homes, to start or grow their businesses.
Pro: Much like investing your own savings in your business, using credit allows you to maintain your independence in running it.
Con: You must be very careful about leveraging credit. If something goes wrong with your business, you could destroy your personal credit rating or lose personal assets, and in some instances your home. Also, depending on when and how you do this, interest rates could make this type of borrowing prohibitively expensive. If necessary, consider limiting credit use to pay for a finite, project-focused part of your business expansion. It can help you control losses and expenses, and it can help limit the damage you could do to your credit or personal life.
Family and Friends
Many business owners turn to family and friends for funding.
Pro: You may be more likely to get the money you need because friends and family want to see you and your business succeed.
Con: The biggest negative of getting funding from friends and family members is that if things go wrong, your closest relationships can be impacted. And when it comes to business, it’s quite likely that things won’t go as planned at one point or another.
If you decide to pursue this course, you must decide how to structure the funding relationship.
Equity: In this scenario, you sell a percentage share of your business in return for cash. Typically, you don’t need to repay the money, but you will have to pay a percentage of your profits over time. This could add up to much more than the original investment if your business is a success.
Loan: You are required to pay back the borrowed dollars, along with interest. But once everything is paid off, you are free and clear.
In either case, you should be prepared that your family-member funders may want to influence your operation.
Tip: Hire a lawyer to draft a formal agreement before taking money from friends or family members.
Customers and Suppliers
Two possible funding sources for small to midsized businesses that want to expand to the next level are customers and suppliers.
Customers can finance your business by prepaying for orders or giving you an advance on them. This type of funding covers individual transactions. It’s likely that customers will be willing to help you out if you’re particularly good at what you do or offer a unique product or service they can’t find anywhere else.
Suppliers can help by giving your business extra time to pay invoices at no extra cost. Getting supplier credit is similar to receiving limited-time financing that’s interest free. Suppliers who value – or need – your business may be willing to extend the timing on your payments.
Pro: Both options give you limited-time financing at no interest.
Con: These are both short-term financing options that support incremental growth and probably won’t help to expand your business in a big way over the long term.
Small Business Administration
The Small Business Administration (SBA) offers microloans to business owners. The maximum you can borrow is $50,000. You may be more likely to be approved for an SBA loan than a conventional loan. The SBA also provides 7(a) loans through financial institutions. These loans are larger than microloans and typically have more stringent qualification criteria.
Pro: SBA loans are relatively easy for small business owners to access, and they typically come with reasonable interest rates.
Con: Not every business qualifies for an SBA loan.
Peer-to-peer (P2P) lenders offer financing to business owners from other individuals. The business owners and lenders are matched through a service usually supplied through online platforms. The platforms also provide a basic level of due diligence. Most P2P loans are relatively small and cap out at around $30,000, although some lenders do offer higher loan amounts.
Pro: Business owners are often able to connect with other owners who are similar to them through P2P platforms. This makes getting financing comparatively easy because it’s based on personal relationships and shared experiences.
Con: With P2P loans, the money is not typically lent to your business. Instead, it’s loaned to you as a private individual. The transaction is dependent on your personal credit and therefore could impact it.
Businesses often find it impossible to grow because they have to wait too long for payment of invoices from business clients. Factoring allows you to finance invoices that are outstanding for a period of time, usually 60 to 90 days. Transactions settle once a client invoice is paid in full.
Pro: Factoring provides your company with immediate working capital. You can use the money for any purpose, including growing your business.
Con: Factoring is based on the creditworthiness of your clients. If it’s not good, you may not qualify for it.
One way to finance the equipment you need to expand your business is to lease it through a finance company. Typically, equipment leases are structured so that the finance company purchases the equipment and rents it back to you for a monthly payment. Once the lease period is over, you are able to buy the equipment from the finance company for a relatively low cost.
Pro: Leasing relieves companies from having to lay out significant amounts of cash upfront for equipment, which is often a major barrier to expansion.
Con: You end up paying more for leased equipment over the long term. This could cut into your profits.
Crowdfunding is a relatively new way of getting business financing. It’s typically an online platform that lets businesses pre-sell products to buyers. If enough customers pre-purchase the product, then you’ll have the capital to move forward producing it.
Pro: Crowdfunding may be a great option if you have a cutting-edge product that people are intrigued by and willing to commit to buying before it’s produced.
Con: Crowdfunding probably won’t work if your product has limited appeal.
Certain banks, especially community-based ones, make loans to small businesses, typically successful and established ones, that are looking to grow to the next level.
Pro: Banks are likely to finance you if you have assets to back your loan and a proven track record.
Con: If you’re unable to demonstrate that your business is solid, profitable and a good risk, banks are unlikely to approve you for a loan.
Venture Capitalists and Angel Investors
Getting financing from these sources is possible if the expansion of your business involves a unique and innovative concept with high margins that can scale quickly.
Pro: If you have the right opportunity, then venture capitalists or angel investors may provide the funding you need.
Con: It’s a challenging process that typically requires sophisticated proposals and polished presentations, and winning funding is rare. If you are approved, your investors may want to get intimately involved in your operations.
Consider government grants, which may be available for companies in specific industries or in certain locations, such as urban development zones.
Pro: A government grant can be a cost-effective way to fund a business expansion.
Con: Government grants can be difficult to come by. Typically, there are also significant limits on what you can spend the grant money on. Be sure to read the fine print before accepting a grant.
In the end, it’s up to you and your financial advisor to decide how to best fund your business. You owe it to yourself to evaluate your options and find the best solutions for your personal situation.
Learn more about how to gain capital to grow your business during changing times as you reopen in our Business Reopening Playbook.
Prepare & Prevent
Selling New Products and Services During a Recession
Finding the right product and service offerings is key in making it through a recession. Learn more about which new products and services you should be selling.
How to Help Streamline Operational Processes and Procedures
Learning ways to streamline business processes and procedures will help to reduce operating expenses during an uncertain time for companies. Learn more today.
The 4-Step PATH to Reopen Your Business During COVID-19 [Travelers Risk Control]
With states easing restrictions, every business needs a strong plan for a successful reopening of the workplace for customers and employees. Scott Humphrey from Travelers Risk Control explains how our PATH Back to Business framework can help.