Sources of Small Business Financing
You've finally decided to open your dream business, right in neighborhood where you grew up. You have a great vision, a business plan, and supportive friends and family. Now you need financing for your small business. Follow along to learn about the various aspects of financing and what your potential options might be.
Equity vs. Debt Financing
Small businesses can get money through "equity financing" or "debt financing." Equity financing means that you sell stock in your company to a buyer, who then has an ownership interest in your company. Debt financing means a loan -- you owe the person who holds the debt (usually a promissory note) the amount borrowed. Here are the most common sources of equity and debt financing for small businesses.
Common Financing Sources
- You: Contributing your own money to your business is the easiest way to finance it. You can tap into your savings, use a home-equity line of credit, or sell or borrow against a personal asset -- including stocks, bonds, mutual funds, or real estate. You can contribute money as equity or make loans to your company.
- Family and Friends: Mom, dad, relatives, and friends may have access to more cash than you do. They may be willing to lend you money, or they may be willing to take an equity stake in your company.
- Small Business Administration:The Small Business Administration (SBA) offers a number of loan programs to small businesses. The 7(a) Loan Guaranty Program is one of its primary programs. Through this program, the SBA provides loans to small businesses that are not able to obtain financing on reasonable terms through normal lending channels. You can apply for these loans through your local participating lender (usually a bank).
- Banks: Banks make a lot of loans to small businesses. However, they are usually the hardest place for the start-up business to find money, because banks like to see that a company has a history of making money. The bank wants to be reasonably sure that your company will be able to repay the loan. If you have a good business plan and have personal assets that you can offer as collateral (or if you have a guarantor or cosigner who is satisfactory to the lender), you may be able to qualify for a bank loan even if your business is a start-up business.
- Credit Cards: If you have a credit card, you have a built in line of credit. Although credit cards are one of the most costly ways to finance your company, they are routinely used as a source of funds for start-up businesses.
- Leasing Companies: Leasing companies are a way to finance computers, office equipment, phone systems, vehicles, and other equipment. Leasing can lower your start-up costs because you won't have a large initial outlay of cash for the equipment.
- Customers: If you have existing customers, they may be willing to pay you in advance for your products. This allows you to use their money to purchase products or inventory prior to sale.
- Trade Credit: Vendors and suppliers are often willing to sell to you on credit. This is a great source of financing for both start-up companies and growing businesses.
- Small Business Investment Centers: Small Business Investment Centers (SBICs) are licensed and regulated by the SBA. SBICs are privately owned and managed investment firms that provide venture capital and start-up financing to small businesses.
- Venture Capital Firms: Venture capitalists provide funds to companies that they believe have exceptional growth potential. Very few small businesses are able to obtain financing through venture capital firms.
- Investment Banking Firms: Investment bankers "take companies public." That means that the investment banker offers stock (an ownership interest) in your company to the public. This option is generally only available to small businesses that have very strong growth history and very strong growth potential.
- Private Placement: A private placement is an offer of stock (the stock gives the buyer an ownership interest in your company), or debt (you owe the holder of the debt instrument, much like a loan) to wealthy individuals or venture capitalists without going public.
Now that you have an understanding of financing basics, you'll likely want to know what's right for your specific situation. Contact a business law attorney today to learn about the laws in your state and how to make your dream business into a reality.