There are many different types of funding for small businesses. Here's a breakdown of some of the most common types and when each is right for your business.
There are many ways to fund a small business, but not all of them make sense in every circumstance. Some – like conventional bank loans – are cheap but difficult to get. Others – like invoice financing – are easy to get but expensive. This guide offers a look into some types of SMB funding and when they are right for your business.
Types of SMB funding
|Conventional bank loan||Low rates and simple terms|
|SBA loan||Lower credit requirements and long loan terms|
|Business line of credit||Revolving credit that you can borrow against repeatedly|
|Invoice financing and factoring||Quick funding and few qualification criteria|
|Equipment financing||Low-interest term loans that are fully collateralized|
|Revenue-based lending||Repayment directly tied to revenue|
|Small business credit card||Rewards on normal daily purchases|
|Crowdfunding||Engagement with potential customers|
|Bridge loans||Funding for projects until you can lock in long-term financing|
|Equity financing||Strategic partners to help your business grow|
|Friends and family||Loved ones sharing in your success|
|Personal savings||Control of your own business and no servicing debt|
Conventional bank loan
When someone needs to secure funding for a small or midsize business, the first place they typically look is a conventional lender like a bank. There's good reason for this: Conventional bank loans typically have the lowest rates and are the most straightforward funding option. A bank simply lends you money that you repay over time in fixed monthly payments.
Bank term loans are great for business if you have excellent credit and/or an existing relationship with a lender. Otherwise, though, this type of financing can be difficult or even impossible to get.
In case a bank loan isn't an option, the Small Business Administration has numerous programs to help fund small businesses. Each program has different terms and potential uses of funds, but they all generally have lower qualification requirements than conventional bank loans.
The thing about SBA loans is that they are not designed to be a first option for funding – the SBA is generally a lender of last resort. If you can get funding elsewhere, you don't qualify for SBA funding. Even if you do qualify and need the money for an eligible purpose, SBA loans can still take quite a while to secure.
Business line of credit
A business line of credit (LOC) is a revolving credit facility – money that's made available to business owners, which they can borrow from as they need it. Then, they make regular (usually monthly) interest payments, but just against the amount that they've borrowed. They repay money they've borrowed as they are able and then borrow those funds again when they need them.
Lines of credit offer a lot of flexibility, since they aren't structured loans with fixed payments, but they only last for a certain period of time. Before your line of credit expires, you need to have paid back the loan in full, gotten an extension, or converted it to a structured loan. If you need long-term financing for a large project, a fixed loan may be better.
Invoice financing and factoring
There are two types of invoice-related financing: invoice financing and factoring. Invoice financing lets business owners borrow against the value of their outstanding invoices and repay the loan over time. Factoring is basically selling invoices to a factoring company at a discounted value. Both options let business owners get access to their cash quicker than they would if they waited for their clients to pay.
Invoice financing is generally fast and easy to qualify for, but it's not cheap. That means that it can be ideal to meet short-term financing needs like making payroll, but it's not necessarily good for financing big purchases or long-term projects.
Equipment financing is a term loan against a piece of equipment or machinery. These loans are similar to traditional car loans, but they typically charge higher interest rates, since they aren't consumer loans.
The big downside of equipment financing is that it isn't very flexible in use of funds. These loans can be great if you need to finance new equipment to build your business, though – for that, there are few better options.
A revenue-based loan is a type of financing taken against an asset, just like any other loan. Using revenue-based lending, business owners can borrow against some type of collateral, such as real estate or equipment. Many of these loans are issued by hard money lenders that have lower qualification requirements but also higher rates and other costs. Some also offer flexible repayment that is tied to revenue.
If you've exhausted other avenues and you own equipment or other collateral that you can pledge for a loan, revenue-based loans may help you secure funding quickly.
Small business credit card
Small business credit cards work almost exactly like personal credit cards, but they're designed for business spending and business rewards. As with personal credit cards, underwriting is usually based on the business owner's personal credit. Business credit cards can also be used to help build a business's credit score over time.
Business credit cards typically don't have huge credit limits and can only be used for certain expenses. They can be great if you want to finance normal daily expenses, but they're also very expensive if you need to finance things over several months. Some cards have long 0% APR introductory periods, but unless you're using one of those, conventional term loans are better for long-term financing.
If you need to raise capital for a new business, crowdfunding is one way to gather small amounts of funding from many sources. Business owners who want to go this route can build an online campaign and create a pitch to get noticed and secure their backing.
The big advantage of crowdfunding is that money doesn't usually have to be paid back, unless funding is being obtained through a peer-to-peer lending network. Still, crowdfunding works best for companies with creative founders or those who want to build a following or engage with potential customers.
It's hard to get noticed on crowdfunding platforms, though, and there's no guarantee that you'll get funding. Even if you do, there's also no guarantee that you'll get funds quickly. So, crowdfunding can be a good idea if you're starting a business in your spare time or have other sources of funding to float your business while you run your campaign. If you're already operating your business or need funds quickly, you should probably look elsewhere for funding.
Like invoice financing, bridge loans can be ideal for short-term financing. Unlike invoice or equipment financing, these loans aren't usually tied to specific pieces of equipment or receivables. Instead, they're often tied to things like real estate. Basically, they're used as a short-term loan until you lock in long-term financing. That way, you don't miss out an opportunity to grow your business – you can get the funding you need and move forward with the project once permanent financing comes through.
One option for funding your small business is to avoid debt entirely by raising money from investors. Under this arrangement, those investors become partners in business and own shares in your company, entitling them to a portion of your future revenue. If you raise enough equity, you may actually have to give up majority ownership of your company, in which case your investors can actually control the business.
Equity financing is best for high-risk businesses – ventures with a high likelihood of failure. These include tech companies – businesses at the forefront of innovation that may fail or be beaten to market. For other types of ventures, however, it can be very hard to attract investors. So, if you're starting a more conventional business, you may want to consider more conventional funding sources.
Friends and family
Financing from friends or family can take two different forms – raising equity or getting a loan. The difference is that it's from people you know – a private loan or a private stock offering. So, it may be easier if you have friends or family who have money to invest, believe in your mission, or want to participate in your business. However, this isn't really an option for people who don't have wealthy friends or family.
Also called bootstrapping, this is what most people think of when starting a business, but you can also use your personal savings to finance ongoing operations or new growth. Of course, not everyone has savings to finance their business – about 70% of Americans have virtually no savings at all.
If you do have personal savings and believe in your business, tapping those savings can be a great, low-cost way to finance your operations. If you don't have much savings or access to other types of funding, personal savings may not be your best option – if it's an option at all.
Whether you're just getting started or looking to take your business to the next level, there are lots of ways to fund your small business, from savings to loans, friends and family to crowdfunding. With so many options, though, it can be tough to know where to turn for the money you need. So, before you go looking for the funds to grow your small business, be sure to consider your options and decide which is best for you.