Looking to start a business? Plan on obtaining financing? Are you thinking of traditional or alternative financing, general terms or a Small Business Administration (SBA) loan? First, you need to understand a few things about the world of business financing.
There are many questions you may have about financing prior to jumping into business. This article will answer a few of them and also provide a few tips for you along the way.
QUIZ: WHAT BUSINESS IS BEST FOR YOU?
Traditional versus Alternative Financing
Traditional business financing is easy to understand. It is what you see on television or what one would think when first opening a business. You simply walk into a bank and apply for a loan. Of course, it sounds easier than it is, as you must have things such as a business plan with financial data, but just think of this as the “traditional” way we are all used to obtaining financing.
Alternative financing is everything that does not fall into the definition of traditional financing. Alternative financing can include crowdfunding, equity crowdfunding, working capital loans, etc. Generally, alternative financing is done through companies outside of banks.
Angel Investment and Bootstrapping
Even if you choose not to finance your business, you still need funds to operate. There are two ways to do this. The first is through angel investment, and the other is through bootstrapping.
Angel investment is when you receive capital from a person or business to use as if it were a loan. The money is considered an investment instead of a loan and the investor is normally given a share of the company along with special consideration (e.g., management rights). This is typically the type of investment you will see on the television show Shark Tank.
Bootstrapping is when you use your own capital to run the business. You may have heard of a business being “bootstrapped” which means it is receiving no outside funding whatsoever. The benefits of bootstrapping is that you maintain 100 percent control of your business and don’t have to pay anyone interest on a loan. The bad news is, you are dumping all of your personal savings into a business in the hope that it succeeds.
According to Anand Rajamaran, bootstrapping should be your last resort if all other forms of financing fall through. “This is the only option if you cannot satisfy the criteria for either VC or angel,” writes Rajamaran in an Inc. article about financing options. “But, beware of remaining too long in this “bootstrap mode.” An outside investor provides a valuable sounding board and prevents the company from becoming an echo chamber for the founder’s ideas. My advice is to bootstrap until you can clear either the angel or the VC bar, but no longer.”
Understanding the Basics of an SBA Loan
You may have heard the term “SBA loan”, but that is simply the term used to describe the program. In fact, the SBA loan is not a loan but a guarantee. The way SBA loans work is you will receive traditional financing from a bank that is an SBA lender. The SBA (“Small Business Administration”) then guarantees the loan with the bank.
So what is the difference?
An SBA loan has different requirements which makes obtaining a business loan easier, including requiring a lower down payment than traditional loans. The benefit of an SBA loan is that banks are normally more willing to loan money when there is a government guarantee attached to it. As such, SBA loans free up funds when most lenders would not loan the money.
Don’t Borrow More Than You Need
If you are trying to obtain a loan, you should already know how much money you need to borrow. If not, you have no business asking for money. Knowing how much you need is a key part of asking a bank for money. They want to know how much you need and exactly what you want to spend it on.
It can be tempting to ask for more money than you need. Sometimes a bank will even offer more than you ask for to make sure you have enough. Don’t be tempted into doing so. Take only the amount you need.
“You’d be surprised how many times we’re asked to repeat this advice, because it’s not what most business owners hear when they speak with a firm in the alternative lending marketplace,” writes Rick Nischalke, in a blog post about safe business lending advice. “On the contrary, most firms head in the opposite direction: they want business owners to borrow as much as humanly possible (and maybe a bit more after that!), because it means more fees and profits.”
As stated above, taking more than you need only benefits the lender. If you need additional funds down the road, a lender should be more than willing to provide you with your request as long as you can show them the need and ability to pay.
Summing it Up
Obtaining financing for your business is not that difficult as long as you know what type of funding you want to receive. There are various methods for obtaining funding so know which type you want before jumping into the water. Also, never borrow more money than you need as it only benefits the lender, not your business as a whole.
Brian Horvath is a freelance writer from Michigan and founder of MyBusinessTalk. He is a journalism graduate and a regular contributor to numerous online magazines and journals.