7 Sources of Funding for Businesses & Tips For Choosing Your Best Option
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Starting a business takes passion and dedication. Finding the best sources of funding for businesses is all about attention to detail.
Whether you are a first-time entrepreneur or you have experience as a small business owner, you will need more than a good idea to get started.
In this article, we explore the various sources of startup funding that are available for aspiring business owners. We also touch on why choosing the right source of financing could make or break you.
Let's get started!
Contents
Traditional Sources of Funding for Businesses
Banks, venture capitalists, and angel investors are traditional sources of funding for businesses. They usually offer prolonged repayment time compared to alternative business funding options.
If approved, you will be bound by a contract and will have to repay the loan in monthly installments.
Key facts to note about traditional loans are they tend to have:
- Higher Loan Amounts - Loan sums are usually higher than alternative funding.
- Lower Interest Rates - Government-guaranteed loans have generous terms and lower interest rates.
- Longer Repayment Time - Terms usually range from one to 25 years. Short-term loans from non-traditional sources tend to be between six and 18 months.
- Fixed or Variable Interest Rates - Traditional loans have fixed or variable interest rates.
- Collateral - You will need real estate, motor vehicles, stocks, and bonds to use as collateral.
Bank Loans for Business Funding
With a clean track record and a solid business plan, you stand a good chance of receiving finance.
Shop around to find a bank that meets your unique needs. Loan packages tend to differ from one bank to another. You can use a standard loan calculator to get a rough idea of what’s out there while you prepare for your request. Keep in mind that this will only give you an estimate. It might not reflect the actual terms of your business loan should the bank grant you one.
Read the fine print to understand all the terms, conditions, and fees associated with any bank loan you are considering.
Venture Capital as a Business Funding Source
Venture capital is a form of private equity financing provided by an investment firm or a professional investor. These financers are also known as venture capitalists.
A venture capitalist provides seed funding in exchange for an ownership stake in the company. They often take an active role in guiding the company, which can assist in generating a significant return on investment.
While a venture capital firm can be a valuable source of funding for startups, it is also a high-risk, high-reward financing option. The reason is that many startups fail within the first few years. VC firms invest in startups with unproven business models and untested products or services. This makes it difficult to predict which companies will succeed and which will fail.
Angel Investors for Business Funding
Angel investors are wealthy individuals who invest their money in exchange for a share of ownership in a company. Unlike venture capital firms, they use their net worth to finance small businesses.
Angel investors are often more patient and flexible than venture capitalists. These investors may be willing to provide smaller loans payable over an extended time. This generosity can help ease the financial burden on new businesses.
It's important not to become complacent because Angel investors will still want to see a solid business plan. Decide how much equity you are willing to exchange for the funding. You don't want to give away too much ownership of your business because this can result in losing control if things don't go as planned. But, if you find the right angel investor, you will receive valuable support and resources to help your business grow and succeed.
Alternative Business Funding Options
So what happens if you have an imperfect credit history or don’t qualify for a traditional loan for small business funding?
To meet demand, new types of financial service providers have emerged. These providers range from independent financing partners to small non-traditional banks. The most popular on the list are crowdfunding, grants, and peer-to-peer.
Finally, whether it’s the first or last resort for business financing, there is always the bootstrapping option.
Crowdfunding
Crowdfunding is perfect for entrepreneurs in art, design, tech, film, food, gaming, music, and publishing.
Startups in these fields often struggle to get financing from traditional banks and investors.
Although it could take longer to raise funds, crowdfunding allows creators to build a community around their work. This can generate future income. This option of business funding can also serve as a way for people to support causes or projects.
Examples of equity crowdfunding platforms include Kickstarter, Indiegogo, GoFundMe, and Patreon.
Grants
A grant is funding awarded by government agencies, non-profit organizations, and private foundations. They don’t need to be repaid to the investor. Businesses that empower the community can apply for a grant (for instance, check out some Amazon small business grants).
Small business grants are a valuable source of funding for start-ups. They are sought after, and getting one can be a competitive process. Grant candidates must provide detailed business plans to prove their potential for success.
Peer-to-Peer
In recent years Peer-to-Peer (P2P) business funding has become popular.
P2P is often a win-win situation for both businesses and investors. Companies can access funds and enjoy more flexible repayment terms. Investors could earn higher returns than via other investment options.
Examples of P2P platforms include LendingClub, Funding Circle, Upstart, Kiva, and Bitbond.
Bootstrapping
Whether it is by choice or because you can’t secure a loan, there is still a financing option to explore.
A bootstrapped founder will use personal savings to reach their goals. A bootstrapped company may take pre-orders for its product, then use the pre-payments to deliver the goods.
On the upside, an entrepreneur has control over all their business decisions. On the downside, this form of financing might place unnecessary financial risk on the entrepreneur.
If you are considering starting a software business, do read our article on how to launch a bootstrapped software product.
Choosing the Right Business Funding Option
Securing the right small business funding option is crucial for any business looking to grow and thrive. With so many funding options available, deciding on the best one could be overwhelming.
From the get-go, consider the key criteria and factors that can help guide your decision-making process.
Key Criteria for Evaluating Business Funding Options
The key criteria to consider when evaluating business funding options include:
- Funding Amount - Different lenders offer different loan amounts.
- Interest Rates & Fees - The most cost-effective option could be the loan with the lowest total cost.
- Loan Terms - Some loans could need collateral, while others might have restrictions on fund usage.
- Application Process & Funding Speed - Different financing options can vary in complexity and speed.
- Repayment Flexibility - Some lenders offer flexible repayments. They might also adjust payment amounts based on cash flow.
- Credit Requirements - Lenders have different requirements for credit scores and credit history.
- Lender Reputation - Factors such as customer service, reviews, and track record of successful loans all add to a lender's reputation.
Factors to Consider for Business Funding
Important factors to consider when seeking small business funding:
- Business plan: Demonstrates your business's potential to lenders.
- Business Stage: Different funding options may be better for businesses. For instance, a software startup in the seed stage may be better suited to bootstrapping to cover initial expenses. A mature company wanting to open a new branch might be better served by seeking private equity or venture capital funding.
- Industry Specific: Some lenders specialize in certain industries or sectors.
- Business Credit Score: Check your business credit score with the credit union, and address any issues before you apply.
- Collateral: Consider the potential risks of offering collateral if you have it available.
- Cash Flow: Make sure you will have the cash flow to repay your loan. Each lender has terms of their own, and failure to pay can have serious consequences. These repercussions can include damage to your credit score, legal action, and bankruptcy.
- Tax Implications: Consult with a tax professional to understand the potential tax consequences.
Tips for Securing Business Funding
Here are some quick tips for securing small business funding:
- Ensure your financials are accurate and in good shape
- Develop a strong business plan
- Research your funding options and choose the best fit
- Network and build relationships with potential lenders and investors
- Be prepared to provide detailed information during due diligence
- Consider a co-signer or guarantor if necessary
- Stay flexible and consider alternative options if your small business loan doesn’t work out - don’t give up
Sources of Funding for Businesses - Conclusion
In conclusion, the various sources for funding businesses each have benefits and drawbacks.
Traditional bank loans are a popular choice, but it can be hard for small or new businesses to secure them. Crowdfunding, angel investing, and venture capital are much more flexible than traditional loans, but getting them might take more work. Self-financing is also an option for entrepreneurs who use personal savings or assets.
To make the best decision, research each funding option to understand the costs and risks. The road to success is rarely easy. But, with the right resources and support, you can achieve your business goals. Seek mentors, advisors, and networking opportunities to guide you along the way.
Not sure about the type of business you want to start? Then I recommend you check out these three articles:
- 51 Small scale business ideas for entrepreneurs on a budget
- 30 Business ideas for women
- 21 Small business opportunities for veterans
All that’s left to say is that we wish you success with your new venture!
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