Business financing can be a minefield if you’re starting a business or trying to grow an existing one. But taking the time to consider your options, build a plan and talk to experts can set you up for success in the long run. We asked Holly Wade, executive director of the National Federation of Independent Businesses Research Center, how to raise money for business and decide which common business funding sources fit your needs.
Tip: Before you start raising capital for your business, create a business website. It’ll function as a virtual business card you can share with potential lenders and investors.
How to raise money for business
Whether you want startup financing or capital to grow your business, these tips will help you make your case to lenders and investors.
01. Create a strong business plan
A strong business plan should be the first step in raising capital for your business. If it can’t stand up to some poking and prodding, most lenders and investors won’t hesitate to say no. You need to show them (and yourself):
You know how much money you need
You have a strategy to efficiently use that money
You have an estimate on how long it will take to see a return on the investment
Wade says you can use a strong business plan not only to sell people on your idea but also to facilitate a conversation about your business with a financial expert. “Talk to a small business loan officer at a local bank about your business plan and what might be available to you and in what time frame,” says Wade. “I think having that conversation is really important to build that relationship.” Those talks help show the loan officer you’ll run your business methodically and that they can trust you with the bank’s money.
02. Apply to SBA-guaranteed lenders
Wade recommends looking for banks participating in the Small Business Association (SBA) loan program. They’ll offer loans to small businesses more willingly. “They can offer these loans with the assurance that the SBA will guarantee the loan if the small business owner defaults,” she explains.
In addition to being more accessible, SBA-backed lenders offer benefits like lower down-payments, flexible overhead requirements and unsecured loans. In some cases, the lenders also offer counseling as part of their business banking services and won’t require collateral. Although the interest rate for SBA loans (9.25–11.75%) is higher than that of a traditional bank loan (3.19-6.78%), it’s still competitive.
03. Beef up your resume
Banks reject business loan applications when they think the applicant doesn’t have the understanding, experience or commitment to run your business effectively in the long-term. Working at a similar business for a year can introduce you to the industry and show your loan officer you know what it takes to start your own. If you’ve worked in the industry outside of a managerial role, consider taking a business class or two to learn the basics.
04. Carefully consider your financing options
Don’t just take the money offered to you. Think carefully about the risks and benefits of each business financing option. If asking someone to invest, think about whether you want to tether your business to the investor in the long-term. Ask them about the role they expect to play and what they want from the partnership.
05. Watch out for predatory lenders
A good lender or investor will likely consider your pitch or application thoughtfully. If the person is pushy, you can assume they don’t have your best interest at heart and may even try to pressure you into a bad loan. “It’s always good to take a breath, step back, think it through and see if there’s any more information before going forward,” says Wade. “If you’re just not quite sure about it, talk about it with a small business loan officer, a SCORE business mentor or other small business owners.”
Watch out for these predatory lender red flags:
The contract doesn’t list the annual percentage rate (APR) or the full payment schedule
The APR is higher than 36%
The deal seems too good to be true
The fees exceed 3% of the loan value
The lender asks for an up-front payment
4 small business funding sources
Most small businesses rely on four traditional small business funding sources. Here, we’ll discuss the pros and cons of each to help build your business financing plan:
01. Personal assets
In most cases, people use personal assets for business financing. According to the United States Census Bureau, 74.7% of small businesses contribute their own savings to their startup capital. Additionally, 10% use personal credit cards, 6.3% use home equity and 10% use other personal assets.
Wade explains that ease, security and availability make people rely on personal assets for business financing. “It’s generally very hard for a business to access financing through a bank unless they’ve been profitable for a few years,” says Wade. “Also, most startup businesses don’t want to start off in debt.”
If you do need to raise more money than you have in the bank, investing your own money (often known as bootstrapping) shows investors you’re committed to and confident in your business.
02. Friends and family
It can be a safe bet to source your business financing from people who know you and believe in your mission. Unlike investors and banks, your friends and family will less likely charge you high interest rates (if they charge you any at all). Additionally, it won’t ruin your credit if it takes you longer than expected to turn a profit.
Keep in mind, though, your friends and family may want more transparent information about your business’s health than a bank would since they’ve assumed a high risk. Additionally, you risk damaging your relationships if you can’t pay them back in the agreed-upon time frame.
To prevent any unpleasant scenarios, complete your due diligence. Make sure you have the full picture of your existing finances and a return-on-investment projection that shows you can pay off the loan. Work out a loan agreement that clearly sets the expectations and repayment timeline.
Even with investors and crowdfunding, business loans still remain a core option for raising money for business. After personal savings, Bank loans were the second-most-common business financing option. Still, the process is difficult. “Banks are not in the business of lending money to startup businesses because of the risk involved,” says Wade. “And most startup businesses don’t want to start off in debt.”
Because of the mutual hesitancy, only 19% of small businesses use bank loans for business financing. That said, a loan may be a viable option if you and your loved ones don’t have the capital you need to start a business.
04. Credit cards
Credit cards aren’t as popular as learning how to get a startup business loan because of the high interest rates and short pay periods. Businesses do find them useful for subsidizing cash flow. If you can’t keep up with bills and don’t have access to emergency funds, a credit card can help keep things moving.
For both startup and existing businesses, credit cards serve the same purpose: immediate access to business financing. “The access is sometimes far more important than the actual cost of financing if it immediately benefits their business,” says Wade. “If it takes them a few months to pay it off at a higher interest rate, it’s still worth it.”
6 alternative sources of small business funding
According to the SBA, only 10% of small businesses used venture capitalism, grants and crowdfunding to start a business. Highly scalable businesses like tech or product startups primarily use these options. “Most small businesses don’t take on angel investors or VCs,” says Wade. “Your local dry cleaner or hardware store wouldn’t be in the market unless they were expanding rapidly in an area.”
If you have big ambitions for your small business, try one of these alternative business financing options:
Crowdfunding uses online fundraising tools to gradually raise small funding amounts from many different people. Just figure out how much you’ll need to get your business off the ground, choose a suitable crowdfunding site and develop a marketing strategy to boost your fundraiser’s visibility.
02. Angel investors
An angel investor uses their own wealth to finance startups in the early stages of development in return for stock or equity. This financing option appeals to businesses because angel investors can provide mentorship and often don’t require repayment if your company fails. Still, their stock or equity gives them some control over your business, so you’ll want to vet angels as carefully. If you can’t find any investors in your own personal network, search sites like Angel Investment Network and AngelList.
03. Venture capitalists
While angel investors fund starting businesses, venture capitalists (or VCs) tend to focus on scalable startups. Because they work in partnerships or firms, VCs can offer more money and resources than angel investors and can take on riskier endeavors. They don’t require repayment, but they often require a controlling interest in the company, as a form of equity finanncing. You can find venture capitalists through the SBA’s investment program, the National Venture Capital Association or Gust.
A business incubator is a commercial workspace for new ventures to grow into successful businesses over a short time period. The incubator will support your business through its early stages, offering everything from equipment and mentorship to marketing and administrative support. Check out the International Business Innovation Association (InBIA)—which claims to be the largest member-based entrepreneurial support network in the world—to find an incubator that fits your business.
Grants offer businesses freedom, but they are rare and competitive. The federal government offers a few grant programs, but many are for research and innovation. You might have more luck with private grants that offer opportunities for traditional small businesses, such as the Walmart Local Community Grants or Amazon’s Black Business Accelerator Program. Check out the US Chamber of Commerce’s list of federal and private grants to learn more.
06. Product presales
If your business will launch a particular product, you can invite future customers to pay ahead to fund your production and distribution costs. This business funding strategy helps gauge public interest in your product and help you avoid under- or over-production.