The road to starting a successful business can be a long one, filled with many hurdles and obstacles along the way. And perhaps there is no part of that journey more challenging than finding the right way to fund your business. While the process may sound daunting, there is a light at the end of the tunnel for future business owners, who now have a multitude of ways to finance their business. Here’s an overview of some of the traditional and creative financing options available to those thinking of starting their own business.
Small Business Administration loan
The Small Business Administration (SBA) was started in 1953 to encourage aspiring entrepreneurs to start their own businesses. Under the SBA, there are two types of loans that can help prospective borrowers get the capital they need to start their business: a 7(a) guarantee small business loan and the 504 fixed-asset small business finance program.
The 7(a) guarantee loans for small businesses are more common for small businesses. Prospective borrowers can apply for these loans at banks that participate in the SBA loan process.
“Both programs look for businesses not in the startup phase,” said Chuck Evans, co-founder of Prudent Lenders LLC. “They look for businesses two years into the business cycle that are generating cash flow.”
These loans have a number of advantages for small businesses.
“The advantage to the borrower is, they have more access to capital,” said Evans of the 7(a) guarantee loan. “When borrowing with a loan, collateral or purpose often dictates the terms. If you look at real estate, you are looking at a 20- to 25-year term. If you are financing equipment, you look at the useful life and may finance it for five years. With a guarantee from the SBA, banks can go up to 10 years for working capital, 10 years for equipment and 25 years for real estate. It gives the borrower longer terms and improved cash flow.”
“Because the loans are sold in the secondary market, they tend to structure a lot of those loans on a variable basis,” said Evans. “The interest-rate risk is greater on the 7(a) program.”
Additionally, borrowers must make a smart choice when choosing a lender, Evans said.
“If you take 100 banks in the state of Pennsylvania, maybe only 20 banks made more than 10 SBA loans last year,” Evans said. “If you deal with that few loans a year, you are not going to be able to understand the nuances of a program that is constantly changing, so it can turn into a slow and cumbersome process. If you go to a bank that does it well and does it on a regular basis, you stand a much better chance of a more simplified process because they understand it.“
Selling your products
Selling your products is an often-overlooked way of raising the money needed for financing your business, but it can be highly effective. Priska Diaz was able to raise $50,000 for her company Bittylab with a presale of her Bare air-free baby bottles.
“I decided to take a different path [in financing] and do a presale,” Diaz said. “That allowed me to drive traffic to my site, get additional social media followers and offer my customers discounts. It was a win-win approach.”
The money Diaz was able to raise helped her pay for inventory, and also helped to open some doors in retail and learn about her website’s visitors. Though Diaz was able to benefit greatly from this means of financing, she does have a word of caution.
“The biggest challenge was in coordinating the inventory delivery times from our supplier so that we could start fulfilling orders,” Diaz said. “Another challenge was forecasting the number of units we were going to presell, resulting in a shortage. We’ve now passed the presale stage and sold more than originally anticipated, resulting in back orders.”
Friends and family
Know of a rich aunt or a wealthy friend who has some extra money to throw around? Then you have another way to finance your business. Borrowing from friends and family presents an interesting alternative to traditional forms of financing, and can have some unique advantages.
“If you are in an early stage of business, you are going to be forced to go to friends and family because the banks may not entertain your requests,” Evans said. “Also, friends and family are not going to charge you a high price for that investment. This funding is available when you need it and with less contractual hassles.”
However, Evans cautioned that those who use these methods risk muddying personal relationships with a business decision.
“The downside is that you risk lots of other things within the family dynamic,” he said.
Having another business
New business owners can also look to double dip as a means of funding their startups. Alex Genadinik was able to do this by using the revenues from tours he led on the website ComeHike.com. On that site, Genadinik was able to organize hikes to fund Problemio.com, which builds mobile apps for planning and starting a business.
“I tried everything else before that, including monetizing with ads and becoming an affiliate reseller for outdoor gear, but it didn’t quite work,” said Genadinik. “So this was just one of the things I tried among many others.”
After receiving donations for some of the free hikes he organized on the site, Genadinik began to charge for events.
“That amount of money, plus the other revenue streams, allowed me to break even month to month,” Genadinik said. “That allowed me to work on my project without the distraction of looking for investors. So, I got exercise and maintained my health, used the events to market my site, and earn revenue all in one.”
Home equity loan
A home equity loan is based on the equity the person seeking a business loan has in his or her home. For those who have equity — the home’s value minus what you owe — in their home, this is a great option for financing a small business because they generally offer interest rates that are both flexible and lower than traditional commercial rates.
“Home equity loans, first of all, are very cheap, rate-wise,” said Al Engel, executive vice president of consumer lending at Valley National Bank. “It is a very-low-cost form of borrowing that is very controllable by the entrepreneur as far as when he pays funds and redraws funds. The flexibility is tremendous.”
However, there are potential drawbacks to home equity loans.
“The risk is, you are putting your home on the line,” said Engel. “If the business fails or you fail to maintain the terms and conditions of the home equity loan or line, you risk foreclosure…There is personal liability for home equity loans.”
Other times, financing methods can be right under a business owner’s nose. That was the case for Hamid Saify, who was able to fund his business, ChoicePunch, by making the tough decision to sell a dream car that he had wanted to pass along to his children.
“I realized I needed to get rid of it to support the development of ChoicePunch,” said Saify.
Though it was a tough decision, Saify was able to make $30,000 from the sale of the car. That money, in turn, went toward some very important aspects of the fledgling startup.
“I used some of that money to help with the last payments to our design and development contractors,” Saify said. “The rest I put into our account and used to help support marketing during our beta launch months.”
Other people looking for additional financing for their small business should look no further than their wallets: Business credit cards are among the most readily available ways to finance a business. However, experts warn that there are some significant considerations to keep in mind before swiping that piece of plastic.
“There are minimal advantages to using credit cards to finance your small business,” said Ken Nickel, senior vice president of community lending at Valley National Bank. “One of the few advantages is that the minimum payment on a credit card is very low. If you are a new business who is just starting out and you don’t have a lot of money coming in, or you don’t have a ton of expenses, you can put it on a credit card and pay the minimum payment.”
However, those benefits are far outweighed by several large disadvantages.
“The downside to credit card financing is that it doesn’t go away quickly, and it also costs you a lot of money,” Nickel said. “Particularly if a new business gets started and then has trouble making the payments, the interest rates and costs on the cards can build very quickly. The commercial loan market right now is in a range of probably 5.5 to 6 percent for commercial loans. When you get into the credit card market, you can be looking at interest rates of 24 percent and over. It can be really devastating to a business over a period of time to have to carry that kind of debt.”
Small business owners often rely on credit cards as a means of covering the costs of their businesses, but savvy business owners can use those cards for more than just buying products. Ben Bakhshi was able to transfer credit card balances as a way to fund the $25,000 in startup costs for Coordinato.com, which creates appointment reminder software for small businesses.
“In my case, I didn’t have any credit card debt, but I had two offers for attractive financing,” Bakhshi said, adding that he was able to negotiate those rates even lower.
Bakhshi said the credit card company transferred funds onto another one of his credit cards, giving him a positive balance. Now, he’s required to make minimum payments to the credit card company, and plans to pay off the balance at the end of the year with income generated from the business.
“The money is being used for design work, as well as marketing and advertising,” said Bakhshi. “This all provided much-needed cash flow for my startup, and at a very good price.”
Those looking to finance their business can always look to an angel — angel investor, that is. Angel investors have been responsible for helping to start up several prominent companies, including Google, Yahoo and Costco. This alternative form of investing generally occurs in a company’s early stages of growth, with investors expecting a 20 to 25 percent return on their investment.
“The principal advantage of an angel investor is generally that you have a friendlier atmosphere and a quicker decision-making circumstance for a smaller amount of dollars,” said Mark DiSalvo, CEO of Sema4 Inc., a provider of private equity funds. “You are not going to invest the levels of time, experience and diligence that an institutional investor would require.”
In addition, angel investors can help nascent businesses by serving as advisers.
“Angel investors are an aggregate of smaller high-net-worth individuals that are going to afford fitting in a more appropriate amount of money,” said DiSalvo. “Very few institutional investors today will invest less than $2 million, whereas angels will invest from $100,000 to $2 million easily. You are more likely to get an investor who has strategic experience, so they can provide tactical benefit to the company they are investing in. That could mean that they have customers lined up for them. It can also mean they might have partnership opportunities for these businesses.”
Despite those benefits, entrepreneurs must be sure to find the angel investor that’s right for their business.
“In every stage, the investor and entrepreneur need to make sure they are the right partners for each other,” DiSalvo said. “You have to fit the kind of investment with the need the entity has. That, however, is a difficult thing to discern.”
Winning a contest
Other times, businesses can benefit from a bit of luck. That was the case for Roberto Torres and Luis Montanez, who funded a portion of their startup costs for apparel company Black & Denim with winnings from a business-plan competition.
“We utilized the funds to purchase manufacturing equipment that allowed us to scale our products and meet demand,” the owners said. “This advantage gave us the opportunity to increase our production and get into bigger players like Stein Mart and Walt Disney World.”
In addition to the $25,000 in financing, the pair was able to gain valuable advice about the best way to run their business and how to ensure the company’s long-term success.
“The competition gave us access to business experts that asked us the tough questions while allowing us to retain our equity — a perk that would have been very difficult to obtain otherwise,” the owners said.
While venture capitalists are synonymous with the dot-com bubble of the late 1990s and early 2000s, the truth is that they may be a great source of capital if your business falls into certain categories. For small businesses that are beyond the startup phase and already have revenues coming in, a venture-capital investment may be appropriate.
For a fast-growth company with an exit strategy already in place, venture capitalists present a great way to quickly gain up to tens of millions of dollars that can be used to invest, network and grow their company quickly.
“The benefit of venture-capital investors to a startup is that they can help them get the money and provide them with professional management expertise,” said Brian Haughey, assistant professor of finance and director of the investment center at Marist College. “You may have a venture capitalist who concentrates on physics or nanotechnology. Because they focus on specific industries, they can generally offer advice to the entrepreneur on whether the product is going to fly or what they need to do to bring it to market.”
However, Haughey cautioned, “Sometimes, the money comes in too easily. During the dot-com bubble, the venture capitalists were throwing money at the startups, and as a result, many startups forgot about what they should be focused on,” he said. “A lot of businesses started thinking about fancy offices, and they forget the commercial imperative that they needed to be making money. If money is too available, it lets some people get lazy.”
Beware, though — venture capitalists have a short leash when it comes to company loyalty and often look to recover their investment within a three- to five-year time window.
“They also have to make a return and usually have a five-year time horizon,” said Haughey. “So they invest, and you have to be able to show a profit in five years to return the capital. If you have a product that is taking longer than that to get to market, then venture-capital investors may not be very interested in you.”
Business owners with a Midas touch in real estate can also put that skill to good use in financing business ventures. Shelli Trung, founder of online real estate magazine Investors Beat, has been able to build her business thanks to investments she has made over the past seven years.
“I am currently financing my business with the cash flow from my real estate investments,” Trung said. “Having had some success with property investing over the past years, I have made enough to fund the real estate investing online magazine in its current startup phase.”
Trung has also been able to grow her business out of the startup phase by relying on those investments.
“In the beginning, we used the budget to hire outsourced staff,” Trung said. “However, this did not work very effectively once our business started to grow, and we needed more hands-on support. Now, we use this budget to manage and grow our social media and have started the process of hiring and training full-time staff. Once they are trained up, we will use a portion of that budget as a base salary as our advertising revenue grows concurrently.”
In 2007, software developers began working on a then-unknown personal assistant application. The application — Siri — was bought by Apple three years later, in 2010. One year later, with the release of the iPhone 4S, Siri has become one of the most well-known and intriguing features of the iPhone. Apple’s investment serves as an example of what a strategic investment can provide an upstart company.
“Strategic investing is more for a large company that identifies promising technologies,” Haughey said. “For whatever reason, that company may not want to build up the research-and-development department in-house to produce that product, so they buy a percentage of the company. It is a cheap investment, but the company could turn out to be the next Google or Facebook for them.”
However, those using strategic investing must also think about the restrictions the investing companies may place on them, as they can prevent dealing with any competitors and possibly even cancel the business relationship at any time.
“The first disadvantage would be loss of control,” said Haughey. “You have this great idea, and now you have to answer to someone else, and you have to give up a percentage of your company. The question then becomes, ‘Would you rather have 100 percent of a tiny pizza or 50 percent of a huge pizza?'”
Renting an apartment
Cutting out liabilities is another creative way for new business owners to fund their startups. For Fay Johnson, founder and editor of deliberateLIFE, that meant renting out her apartment. Johnson was able to do this by placing her San Francisco apartment on Airbnb and renting it out for anywhere between five nights and a month at a time.
The decision has been successful for Johnson, who has used the money raised to fund the costs of the first few issues of her magazine.
“The money has been used for a mix of sustaining myself, my assistants and the magazine,” Johnson said. “I have also invested that capital into the marketing and production of the first three issues.”
Though the move has allowed Johnson to finance her startup, it has not come without its share of headaches, including tight time restraints.
“As an entrepreneur, time is one of your most valuable resources,” Johnson said. “When renting, I have to keep in mind that I need to clean and reclean the apartment, and since I work from home, I also have to find a place to work during those days. However, the guests have been great when I have rented the apartment.”
Sometimes, there really is wisdom in crowds, especially if you are looking to start a new business. Crowdfunding on websites like Kickstarter, Indiegogo and others that are geared more toward businesses can give a big boost to the financing aspirations of small businesses. These sites allow businesses to pool small investments from a number of investors instead of forcing companies to look for a single investment. The Jumpstart Our Business Startups (JOBS) Act has been pivotal in helping to popularize this form of financing in recent years.
There are numerous advantages to crowdfunding as a means of financing. Perhaps the biggest is that businesses are able to raise money without giving up an equity stake in their business. Many sites allow companies to raise money in exchange for rewards or products. Other sites do, however, have an equity-based model in which businesses do give up a bit of equity.
Certain sites require businesses to raise their full stated goal in order to keep any money raised on the platform. Other sites will allow companies to keep any money they raise. Additionally, sites can charge a percentage — sometimes up to 10 percent — for any money raised on the site. Sites often also charge a payment-processing fee for money raised.
Numerous businesses have turned to crowdfunding as a means of financing their ventures. One of those businesses, DropShades,was able to raise more than $78,000 on Kickstarter, despite having a goal of only $15,000 on the site. The company produces sunglasses with lenses that can change colors based on the beats of music.
“After coming up with the idea for DropShades, we needed money to cover engineering expenses as well as manufacturing startup costs like tooling,” said Brooks Johnson, chief communications officer at DropShades. “Banks are almost never going to finance startups without a history of sales or collateral. After considering multiple options, we settled on the crowdfunding website Kickstarter. It was the perfect way for us to maintain equity and test the market for our product. ”
The money raised has been invaluable for DropShades, helping fund everything from engineering and manufacturing to preorders and the company website.