Business Funding- Where to Start and Best Options to Consider
Small business owners are no strangers to the financial difficulties associated with launching a new product, updating appliances, or expanding to new locations. In particular, securing funding. One of the most common reasons why small businesses fail is poor cash flow management, insufficient initial funding, and the lack of a well-developed, data-driven business plan.
No business is too small or too large for additional financing options. According to the Megaphone of Main Street's report, as many as 78% of businesses never seek outside funding. Most do not even know how much they need, what the options are, or where to look for them. Identifying these factors is crucial to starting and maintaining a business that prospers and continuously grows.
Whether a business is seeking financial assistance for expansion efforts or cash flow concerns, it's important to understand the various business financing options available to them, as well as the necessary documentation and best practices to increase their chances of approval.
Why is Business Funding Important?
Funding is the fuel that keeps a business running. It enables growth, expansion, the ability to hire new employees, and increase inventory. Without it, companies can too easily drown in financial struggles. Outside funding is most prevalent in the following areas.
- Starting a business - Funding is crucial to get a business off the ground. The initial costs of starting a business can be high since everything - from incorporation to hiring talent - must be accounted for. While most startups use personal finances to get a business up and running, this can turn out to be insufficient.
- Working capital - Most businesses struggle with cash flow, and insufficient financing can significantly impact a business's future. Covering day-to-day operational costs, such as paychecks, insurance, and inventory management are likely to be costly, especially when starting out.
- Expansion - Opportunities such as new locations or products can force some companies to seek additional funding to cover the costs. Financing small business expansion is covered by a growth funding loan that is paid off monthly, enabling companies to forecast the growth of their business and finances as they expand and plan accordingly.
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How Much Funding Does a Business Need?
Unless a business is blessed by an angel investor, money usually has strings attached to it, whether it's paying off interest for a loan or ensuring an ROI for investors. Therefore, it is vital to have an accurate estimation of how much funding is realistically necessary.
The development of a business plan based on accurate financial forecasting is essential to determine the small business funding budget. There are several key steps for estimating funding requirements-
1. Develop a forecast of the funding requirements by creating an estimate of cash flow, projected income statements, and balance sheet.
2. Determine what the funding will be used for specifically.
3. Utilize the financial forecast to establish funding requirements. Once income starts to exceed expenses, additional funding is no longer needed.
4. Plan for contingencies that can disrupt these financial projections.
By following these steps, business owners can accurately project funding needs over longer time periods.
4 Common Funding Options
Financing a new business can seem like a daunting task. Fortunately, there are plenty of funding options to choose from.
Banks are still the first place businesses turn to for loans. However, every company has to fulfill certain criteria in order to be eligible. Criteria may include a good personal credit score and proof of stable cash flow over the last six months.
The SBA, the US Small Business Association, offers lenders a federal guarantee on the loan which makes banks more willing to give loans with lower interest rates and down payments. Therefore, the qualifications to apply for SBA loans are strict and require lots of paperwork.
Online lenders offer fast loans with lower criteria. With lower interest costs and smaller service fees than traditional lenders, acquiring a loan online is often pursued by business owners with poor personal credit histories.
Grants provide small business owners with the opportunity to get financing without having to pay anything back in return. Applying for grants is very competitive, and the process is very detailed. It requires detailed documentation, including the development of a business plan and demand forecasting.
Grants tend to favor innovators, veterans, green and rural businesses. However, there are grants available for all types of small businesses. Some of the most prominent grants are listed on the following websites-
- Asian Women Giving Circle
- National Association for the Self-Employed (NASE)
- FedEx Small Business Grant Contest
The crowdfunding market is rapidly increasing, with progressively more businesses turning to their target audience for funding. With 78% of crowdfunding campaigns exceeding their goals, this comes as no surprise.
Setting up a crowdfunding campaign is hard work and requires detailed research on the best platforms and policies. There are three types of crowdfunding to choose from-
- Reward - Donors offer money in exchange for a reward (e.g., the product or early access)
- Equity - Contributors become partial owners of the company and expect a return on their investment (equity-based crowdfunding should be considered very carefully, as it is subject to strict laws and regulations)
- Donation - Donors simply give money without expecting anything in return to support a person or cause
4. Angel Investors
Private investors can provide funding for small businesses in exchange for a percentage of business shares. While partnering with someone may seem intimidating for a new business owner, it can be a marvelous opportunity to have a trusted mentor that offers to finance a business in its seed stage. Most importantly, this type of funding doesn't come with interest rates or loan repayments.
Finding an angel investor can be a demanding process. Networking, joining business organizations and clubs, and using websites that connect companies with investors is a good place to start. Surprisingly, most investors tend to be in our close circle - family and friends account for 38% of all startup investments.
Choosing the Right Funding Option
Learning about all of the available funding options can become overwhelming. To avoid overcomplication, try to consider the following 4 key factors-
1. How will the funding be used?
For instance, opting for crowdfunding to expand a restaurant franchise would be futile. On the other hand, applying for a credit loan might be more suitable. By taking into account what the funding will cover, the decision of selecting a funding type becomes easier.
2. How much funding is needed?
With the exception of the ultra-wealthy, asking friends or family to provide the funding for a multi-million dollar project is illogical. However, they may be able to help with getting a small business started with smaller investments.
3. What qualifications does the business meet?
If the business owner has bad personal credit or no business history, several traditional bank loan options will be unavailable to them as these are among the most basic requirements of eligibility. Therefore, the owner can turn to alternative options such as crowdfunding or an angel investor as these donors do not expect repayments or interest fees.
4. When is funding actually needed?
If a business needs short term funding quickly, time shouldn't be wasted applying for grants, as the process to determine the grant recipients takes time. Some alternative loan options can be acquired very quickly. Conversely, a company that has enough time can reach out to angel investors to secure funding.
Choosing the right funding option is a difficult process. However, by accounting for various factors and being objective in your decision making, the whole process of obtaining funds becomes easier.
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Why is Acquiring Funding Difficult?
Starting a business can be complicated, with many obstacles along the way. One of the major issues is acquiring funding. The primary barriers new business owners face when acquiring capital include-
1. Lacking a clear go-to-market strategy - Developing a business plan with accurate revenue forecasts is essential for attracting investors or applying for loans and grants. Most entrepreneurs have an idea but lack a clear, data-driven strategy.
2. The disappearance of smaller banks - With larger banks only getting bigger by taking over community banks, startups face the challenge of being forced to apply for loans over $100,000. According to the SBA, most small businesses require only $10,000.
3. The rise of service-based businesses - To get a loan from banks, businesses need to have collateral set against the money. This is virtually non-existent in service-businesses that operate on a cash flow business model.
4. Venture capitalists don't invest in smaller businesses - For a venture capitalist, or VC, to invest, they have to recognize significant growth potential. Therefore, VCs mostly invest in already-established companies, leaving smaller startups with limited outside investment.
How to Increase the Chances of Getting Funding Approved
To apply for a business loan, certain qualifications, such as good credit, have to be met. The process requires significant preparation in order to maximize the odds of success and get approved-
- Preparing financial statements - A business should have financial statements that are up-to-date. The best scenario would be a set of records that show a consistent upward trajectory.
- Measuring cash flow - By dividing current assets with current liabilities, a company can calculate its free cash flow or the amount of money the business has left after accounting for all operating expenses. Strong cash flow showing consistent growth and potential for future scalability will be viewed positively by potential investors or banks.
- Boost sales growth - Being able to demonstrate any increase in sales over the years shows a business with strong growth potential. If the sales increase is relatively minor, justify how increased funding would sharpen the trajectory.
- Building relationships with possible lenders - Networking and establishing relationships with potential lenders helps business owners build their personal status among funders. It never hurts to have a strong relationship with the hand that feeds.
- Risking personal assets - If a business owner volunteers their own personal assets, it can demonstrate a willingness to succeed that impresses investors.
- Evaluating economic conditions - It's easy to underestimate the role that market conditions - on a national and regional level - can play in the funding application process. Businesses should always do their research to understand the broader economic situation before applying for loans.
Forecasting for finances, sales, demand, and market trends using available historical data can reassure businesses and their lenders of the viability of a loan. Furthermore, these projections can provide a clearer picture of exactly how much funding the business will require, and when they expect to pay back their lenders.
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