Financing a new small business is one of the biggest hurdles that an aspiring entrepreneur faces. But it’s not an insurmountable one. There are sources of start-up funds that are not as difficult to secure as many people assume. The key is to determine exactly how much you need, to find the right type of financing for your specific needs, what your responsibilities are to the lenders, and know how to use those funds wisely. A wrong move in any one of these areas could make the difference between success and failure for your small business. Remember, it is not solely the start-up funds but having sufficient funds to sustain the business until you reach a break-even position. In many cases break-even may not occur for a year or more.
Sources and types of small business financing fall into a few broad categories. It will either be debt or equity financing from institutional or informal sources. Debt financing is a loan you pay back. Common sources include: family and friends, personal credit cards, home equity lines of credit, commercial bank loans and bank loans backed by the U.S. Small Business Administration (SBA). To our knowledge we have not been able to identify grants for start-up businesses other than for high level technical development sponsored by departments of the U.S. government such as the Departments of Energy, Defense, Homeland Security and several others.
Some small businesses receive a type of funding from suppliers and vendors in the form of special payment terms, discounts or even direct loans. Suppliers want their customers to succeed because it means more business for them, so they are sometimes willing to help. Make sure you ask.
With equity financing, you offer investors shares of your business in return for cash. Unlike loans, you are not required to pay the money back, but these investors now own part of your business and will want a return on their investment. Venture capitalists work this way, and stock offerings are a type of equity financing. Venture capitalists seek substantial investments, typically more than $500,000 and expect to double their investment within five years.
Other funding or cost-sharing options include partnerships, joint ventures, alliances, co-branding arrangements and business incubators. Incubators rarely offer cash, but they provide crucial support in the form of free or reduced rent, business services and business mentoring.
The SBA offers several financial assistance services for small businesses, including the popular 7(a) loan program. Most U.S. banks participate in the program, which provides loans on a guaranty basis, i.e., lenders structure their own loans based on the SBA's requirements. Details about all SBA loan programs and other helpful information for structuring a financing strategy may be found at www.sba.gov/services/financialassistance.
For each of the past two years the Gallup organization has conducted surveys of small business clients of SCORE. Their findings indicate that less than 10% of the SCORE clients in the survey funded their businesses with bank financing. Almost 90% utilized their savings, equity in their homes, or received funds from family and friends. Less than 2% received funds from venture capitalists.