This article was written by Julian Hills, October 2013 in Entrepreneur Magazine, reprinted by permission
You’ve got an awesome idea, a slick name in mind and the garage space to start your dream business -- but not the cash. I'm not surprised.
Financing a small business -- especially a startup -- is an uphill battle in a crowded field. In the U.S. alone, there are an estimated 27.5 million small businesses. And nearly 80 percent of them get their money through bank loans, credit cards and lines of credit.
It’s no secret that it is harder getting money through those avenues in the current financial climate. But just because it’s a bit of a fight, doesn’t mean your great idea isn’t worth fighting for. Here are some of the ways you can finance your startup, from standing in bank lines to going online:
Bank loans. Once thought of as a go-to option, national banks are still pinching pennies -- even after the Great Recession ceased.
As the economy continues to struggle, and bank loans remain elusive, here are some other financing options:
Finance companies: These private companies provide small, short-term loans. This type of financing often comes in the form of payday loans (or cash advance loans). The individual borrows an amount of money and agrees to pay it back with the cost of fees and interest tacked on to the principal. The lender uses the borrower’s next paycheck or a portion of their income as collateral to pay the loan back. The Federal Deposit Insurance Corporation warns that payday loans could be tricky for people using the cash to start up a company, as even just a $500 payday loan could carry a $100 fee. People will occasionally use these loans to cover immediate personal expenses in the startup process.
Unsecured lines of credit: People with high personal credit scores can often get an unsecured line of credit for their businesses. But it should be noted that this option can come with hefty rates. It’s important to decide if the cash your business is projected to reel in will be adequate to pay the loan back, as failing to do so could impact your personal credit and your business credit. The U.S. Small Business Administration released a report in July noting that lending to small businesses declined last year. Business loans of less than $100,000 dipped to $138.2 billion, from $139.5 billion in 2011. Even though conditions have improved in recent years compared with 2008 and 2009 (the height of the recession), business owners still find themselves facing roadblocks from banks that continue to restrict their lending.
Community banks and credit unions may serve as your next best bet. Since many community banks avoided the housing crisis, they’ll often have money to lend without the same standards as national banks. Local small businesses are finding success with community banks if they can convince lenders they’ll make a profit and pay back the loans.
You might also tap a credit union for available funding. As nonprofit organizations, credit unions may offer better lending terms for borrowers than commercial banks.
Credit cards. Having plastic has its benefits. The perks include immediate access to needed items, cash advances when you’re low on money and a way to track spending. When financing your business with credit cards, a major consideration should be whether you can pay off the balance monthly. Credit card companies know commercial loans are hard to come by and often jack up their rates -- sometimes upwards of 30 percent.
Government assistance. The SBA offers qualified financial assistance programs. While it doesn’t loan money directly, the SBA does set guidelines for loans made by third-party lenders (essentially a commercial loan with negotiated strings attached). Businesses that go this route must first prove they could not obtain financing at commercial banks with reasonable terms.
On the upside: SBA loans are usually structured with longer terms and lower down payments, and may come with lower interest rates. On the downside: SBA-backed loans tend to have a lot of stipulations -- often requiring lots of paperwork and time, as approval can take longer than loans from private lenders.
See if your business qualifies by carefully reading the criteria on sba.gov.
Crowdfunding is a relatively new and increasingly popular option people are using to fund business ideas. Most often, entrepreneurs will use sites like Indiegogo and Kickstarter to raise money from the crowd in return for token incentives like a prerelease product or a T-shirt. This process can cut out professional investors and brokers by putting funding in the hands of regular folks. It also might attract venture-capital investment down the line if a company has a particularly successful campaign.
Another, even newer option: equity crowdfunding through sites like Crowdfunder. Rather than giving funders a T-shirt, startups can offer equity in their companies instead. Know that only accredited investors (people with a net-worth north of $1 million, minus their home's value) may participate in this type of transaction.