Ways to Fund Your Business Using Loans
From term loans to a Small Business Administration (SBA) loan, small business owners have many options to look at when thinking about financing. A loan can help you open the doors of your small business, purchase an expensive piece of equipment, or fill the gap in your cash flow. Taking the pressure off your need for funding can help you focus on other ways to grow your business, like using email marketing.
Applying for a business loan isn’t uncommon. In fact, the SBA found 73 percent of small businesses used financing from 2015 to 2016. Although 37 percent of small business owners said they applied for financing for a business expansion in 2017, loans can be used for a variety of reasons.
You’ve made important decisions to put your business on the path to success, like purchasing small business insurance. Don’t be afraid to look to loans to help your business. Learn about the different loans available for small business owners, and decide which loan can help move your business forward.
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Short and long-term loans
When you think of a loan, you probably imagine a bank letting you borrow an amount of money that you have to pay back. As you pay back the money, you’ll also make interest payments. This type of financing is called short and long-term loans.
The main difference between the two types of loans is the payment period. Short-term loans have payback periods between six months and 1.5 years. For long-term loans, the payback period can be five or even 10 years.
Another big difference between the two types of loans? The interest rate. Interest rates for short-term loans are significantly higher than long-term loans. For example, some lenders provide an interest rate range of nine percent to 100 percent for short-term loans. In some instances, you may even find a lender charging an interest rate over 200 percent. The interest rate for long-term loans ranges from nine percent to 40 percent.
Since short-term loans pair a shorter time frame to pay the loan off with a high interest rate, consider these types of loans when your business needs cash quickly. Let’s say you’re taking a look at your cash flows and realize you have a gap in the next six months. You won’t have enough money to fill the gap. A short-term loan can be the solution. Just be aware that it could put you further into debt because of the quick payback period and high interest rates.
Consider a long-term loan for large expenses. Whether you’re looking to expand your business or make an investment, a long-term loan lets you pay for expensive projects over time. And you’ll pay a lower interest rate than taking out a short-term loan.
Both short and long-term loans have qualifications. To qualify for a short-term loan, you may have to have a minimum credit score of 560. Some lenders may also require businesses to be in operation for at least a year and have a certain amount of annual revenue. The annual revenue requirement varies from lender to lender, but a good rule of thumb is to have at least $50,000.
With long-term loans, the qualifications are more difficult. Because you’re going to be paying off the loan over a longer time period, lenders want to ensure your business can afford it. Lenders of long-term loans generally require higher credit scores. You’ll also have to be in business for longer. Lenders may also require a higher annual revenue amount. With the stricter qualifications, a long-term loan could be harder for a newer small business owner to get.
Line of credit
A line of credit is similar to how a credit card works. A lender provides a small business with a set amount they can borrow. Whatever you borrow from your line of credit, you pay back with interest. Depending on the lender, you may be able to pay it back in full to save on interest.
Financing through a line of credit is different than receiving a term loan. With term loans, you receive a lump sum of cash. That money is paid back over time with interest. Your total line of credit is typically smaller than what you could get through a term loan.
To qualify for a line of credit, lenders want to see consistently good revenue numbers. This shows lenders your business is making money each year and you can afford to borrow money if you need to. You’ll also want to make sure you have a big enough reserve in your business’s bank account. Aim for at least $25,000 in reserves. Lenders may also want a business with a few years of experience and a credit score of at least 500.
Small Business Administration loans
SBA loans aren’t provided directly by the agency. Instead, the agency works with lenders to help provide these loans to small businesses. By partnering with lenders, the SBA helps reduce the risk.
Some of the benefits with an SBA loan include:
- Interest rates and fees that are competitive to other types of loans
- Access to a support system for counseling and education
- Unique benefits, such as lower down payment and no collateral needed for some loans
SBA loans range from $500 to $5.5 million. They can be used for business purposes, but some lenders may have restrictions. The requirements to qualify for these types of loans are:
- Operate a for-profit business in the U.S.
- Have invested equity
- Exhaust financing options
If you need to buy an expensive piece of equipment for your business, equipment financing could be a smart way to pay for it. You can buy equipment without using a significant amount of cash. Equipment financing allows you to make regular payments to pay off equipment. The term of the financing plan varies. It generally doesn’t go past the life expectancy of the piece of equipment. Some lenders may put a maximum term length on an equipment financing plan.
This can help you better manage your cash flows or save your money for other expenses. Interest rates for equipment financing are also lower than term loans. So, you can pay off the equipment without having to worry about a majority of your payments going towards interest.
To qualify for equipment financing, most lenders require a credit score of at least 600. And as with other types of loans, lenders for equipment financing want to make sure your business can afford the payments. That means you’ll have to show lenders your annual revenue amounts and how long your business has been operating.
If you’re planning to open a small business or are in the early stages of running a company, angel investors could help you with financing. An angel investor is a person who invests in your company. Sometimes a group of angel investors will contribute money to help finance your business. In exchange, angel investors expect a high rate of return for their investment. That’s because there’s a risk with small businesses.
There aren’t any restrictions on how you can use the investment money. So you can use the money to open the doors or to expand your inventory or supply.
Since angel investors are using their own money, they’re very careful with what businesses they decide to invest in. If you’re planning to make a pitch to an angel investor, make sure you have a solid business plan. Here are some things to keep in mind when making a pitch:
- Know what your business’s purpose and mission is
- Know what your business goals are and how you’ll accomplish them.
The more you understand about your business and industry and can address any competition or concerns, the better.
So how do you find angel investors? There may be some investors in your area. Start local with your search. You can reach out to business professionals and organizations, such as the local Chamber of Commerce. You can also try speaking with people that work closely with business owners, such as banks or accountants. And don’t be afraid to take your search online. You can find angel investor networks to try to find someone to help finance your business.
While angel investors invest in new businesses, venture capitalists provide financing to established companies. A venture capitalist can be a person or a firm that invests in a company.
The amount of money is significantly higher than an angel investor. The SBA reports the average venture capital deal in 2016 was $11.7 million. For angel investors, the average was $330,000. Venture capitalists also want to see a higher rate of return on their investment, compared to an angel investor.
Pitching to venture capitalists is similar to trying to get an angel investor to support your business. Explain your business plan and what your company does. Because venture capitalists want to work with established businesses, be prepared to show your financial statements. Venture capitalists want to work with business owners that have a thriving business and just need additional financing to take their company to the next level.
There are options for every small business
No matter what stage you’re in as a business owner, looking to loans or people outside of your business to help with financing can be beneficial for your company. Angel investors can be a good source of money if you’re trying to get your business up and running or if you’re in the early years of operating. Loans can be a smart way to pay off expensive equipment, upgrades or expansions. They can also help in the short term if you realize there’s an issue with your business’s cash flow. If you’ve been in business for a while and are experiencing success, but need some additional money to grow even more, consider venture capitalists.
Borrowing money or asking for an investment shouldn’t be frowned upon. You want your business to succeed. And sometimes a loan or investments from an angel investor or venture capitalist can help put you on the right track.