Small business financing is a relatively simple concept—companies require funding for everything from cash flow to expansion, and that financing involves using a range of different channels to acquire the right investment.
The nitty gritty of small business financing, on the other hand, can be much more complicated. Small companies today have a vast number of funding choices available, such as small business loans or startup grants. Each of these sources of funding comes with its own unique benefits and drawbacks.
With so many different funding opportunities, it’s important to understand everything about your business financing options in order to make a fully informed decision. This article will cover some of the most common types of small business financing and what you need to know about them.
1. Term Loans
Also known as medium-term loans, term loans generally target businesses that are already somewhat established and are seen as more reliable borrowers. A term loan involves receiving money upfront and making regular payments until the balance is fully paid off.
While the specific requirements may vary from one lender to another, you are more likely to be eligible if your business has been operating for at least two years. You’ll also need strong personal and business credit scores, as well as high annual revenue.
Compared to short-term loans (more on those below), term loans are typically significantly larger, with reduced interest rates and more time to pay them back. Term loans are one of the most common ways in which small businesses pursue funding.
2. Short Term Loans
Short-term loans work similarly to conventional term loans, but are generally limited to smaller sums and don’t allow you as much time to pay off the balance. For those reasons, it’s easier to qualify for a short-term than for a medium-term loan.
Aside from the limits on how much you can receive, the main downside of short-term loans is their high interest rates. Short-term loans are generally used by newer businesses compared to medium-term loans. While the terms of each loan can vary, short-term loans are generally paid back over a period of up to three years.
3. Small Business Administration Loans
Unlike conventional short- and medium-term loans, Small Business Administration (SBA) loans are backed by the government’s Small Business Administration. This gives banks a much lower level of risk, allowing them to offer larger amounts of money at lower interest rates.
Because SBA loans generally offer terms which are much more favorable to small businesses, qualifying for this type of loan can be extremely competitive. There are a large number of subtypes within this broader category, each targeting a different type of small business.
4. Business Credit Cards
Using a credit card for business financing comes with its own set of risks, but there are also important advantages that come with acquiring a business credit card. Unlike the other items on this list which often have strict qualification requirements, you can receive a business credit card based solely on your personal credit score.
As with any credit card, it’s important to have a detailed understanding of the terms of your business credit card. Another major benefit of a credit card compared to taking out a loan is the ability to continue using credit once you’ve paid off the balance.
5. Friends and Family
While tapping your own network is one of the most common ways to secure early-stage funding, many small business owners are hesitant to ask their family and friends for financial aid. However, asking friends and family for their financial support can be fruitful as even the smallest contributions can add up.
Unfortunately, mixing your business and personal lives can lead to a range of complications that simply aren’t a factor in conventional loans. Everyone involved should be able to separate their personal relationships from the investment.
If you choose to use this method of funding, the best way to avoid problems later on is to put your expectations and terms in writing before any money changes hands. This will ensure that everyone is on the same page and understands what they’re getting into.
6. Small Business Grants
Finally, you may be able to secure funding for your small business with grants. State grants, federal grants, and corporate grants are all highly sought after because they are essentially a “free” source of funding for your business.
The problem is, grants often come with a lot of strings attached in terms of how you can actually spend the money you receive and over what time period. Moreover, many grant programs require you to match the amount of money given to you, meaning you still have to secure other sources of funding.
Additionally, grants can be highly competitive. This is especially true of federal government grants for startup businesses like the Small Business Innovation Research (SBIR)program and the Small Business Technology Transfer (STTR) programs.
If you’re running a small business or startup, you’ll inevitably need to explore a wide variety of small business financing options. By understanding the benefits and drawbacks to each, you can ensure that you receive the funding you need to put your business on the right financial track.