How to Finance a New Small Business

How to Finance a New Small BusinessThe New Year is the time when would-be entrepreneurs spring into action to get their companies started. One important piece of the entrepreneurial puzzle is getting funding for your business. As an entrepreneur, you face a challenging road, and one of the biggest challenges is finding a way to fund your company.

In the current economic environment, getting financing for a startup is very difficult. Many entrepreneurs go about this process the wrong way. They often have unrealistic expectations and think that getting funding will be quick and easy. Because of this, they go unprepared.  Furthermore, they often pursue the wrong sources . For example, pursuing an angel investment won’t help you unless you are in a high growth industry. And, without collateral, most banks won’t give you a business loan regardless of how good your business plan is.

Because of this, more often than not they don’t get funded and their business fails. I know because I see this every day, but it doesn’t have to be this way. It’s a matter of reviewing your options and pursuing those with the greatest chance of success.

Before we review the list of financing options, I’d like to take a minute to dispel a common myth. Many entrepreneurs believe that only good ideas get funding. This is not true. Results get funding. And by “results,” I mean that the entrepreneur has already built a proof-of-concept business that is running at a small scale and producing results. Those businesses have a much greater chance of getting funded. Keep this point in mind as you seek financing.

Option #1: Self-Financing

Most small businesses are self-financed. The owners used their own savings to start the company. I self-financed my own company. It requires a substantial commitment because you need to save for a long time. I had to save for a few years and cash in my stock options. And in a few circumstances, I had to also use my personal credit cards.

The advantage of self-financing is that you do not owe money to anyone. The disadvantage is that you are limited by the amount of money you alone can put into your business. Be careful about taking out a second mortgage or using your retirement money as seed capital for your business.  Many companies that fail do so in their first few years, and you don’t want to put your home – or retirement – at risk.

Option #2: Friends and Family

Asking friends and family for financing can be a helpful way to get funding under some circumstances. Keep two things in mind. First, by asking them to invest, you are risking the relationship. If the business fails, the relationship will almost certainly sour. Second, any family member or friend that invests in your company will most likely want some level of involvement. If you take this route, you have two options: sell a piece of your company or get a loan. Draft a formal financing agreement first and treat all your investors – family and friends included – professionally.

Option #3: Lending Institutions

Most lending institutions do not finance new businesses, especially small companies. The idea that you could meet with a banker, show them a business plan, and walk out with funding is not true. Financial institutions only finance two types of companies: businesses with substantial track records and businesses with plenty of collateral. Ideally, institutions prefer businesses with both traits. However, some institutions have partnered with the SBA and can provide funding to startups.

Option #4: The SBA

The SBA can be a great resource for entrepreneurs, but not many small business owners take advantage of what the government has to offer. The SBA does not make loans directly; rather, it provides guarantees to banks that do. This guarantee allows certain banks to make loans that they wouldn’t make otherwise. The SBA has a simple questionnaire that can help you chose the right financing alternative. Two common options are the 7(a) loan programs and their CAPlines program.

One of their most interesting SBA alternatives is their little-known but very useful Microloan program. This program provides up to $30,000 of funding for very small companies. The program does not require a lot of paperwork and provides training to new entrepreneurs. This option is ideal for new entrepreneurs and I highly recommend it. You can find a list of providers here.

Option #5: Equipment Leasing

This type of financing is helpful if you need equipment for your business. This financing works for a range of equipment types and can be used for computers, tools, and restaurant equipment, among other things. Basically, a finance company buys the equipment you need and rents it to you for a monthly fee. Usually, you can buy the equipment for a nominal price once the lease is over.

Option #6: Purchase Order Financing

This type of financing can be used by companies that resell finished goods, such as importers. Purchase order financing can cover the cost of supplier expenses, and is often used by small companies and startups that have large orders.

Option #7: Invoice Financing

This type of financing is available for companies that sell products or services to other businesses on commercial net-30 terms. Invoice financing works by financing your slow-paying invoices and providing working capital to operate the business. It only helps new companies whose biggest problem is a cash flow shortage.

Option #8: Venture Capitalists and Angel Investors

These types of institutions provide funding to startups in different stages of growth. They are popular because of media stories about companies that got this type of funding and went public. Unfortunately, getting venture financing or an angel investment is nearly impossible. Unless your business is in a high-growth industry and you have an active investor base in your area, I’d steer clear of this option. It will consume a lot of time and not yield results.

However, if you decide to seek this type of funding, keep in mind what I said at the beginning of this article: ideas don’t get funding; results get funding. Approach investors after you have built a proof-of-concept and started the company. It’s a lot easier to invest in a company that already has revenues.

Marco Terry is the managing director of Commercial Capital LLC, a leading provider of invoice financing to small and mid-sized companies in the US and Canada. He can be reached at (877) 300 3258.