Under the right circumstances, borrowing money can give a small business the boost it needs to get off the ground or reach its next milestone. Small business owners have several options for seeking out credit and loans, but it's important to know which small business lending option is right for your business and what information you'll need to demonstrate that your business is a good candidate for a loan.
Startup businesses commonly rely on personal loans from relatives or borrowing against credit cards to finance their ventures. Lines of credit and business loans are easier for more established businesses to obtain, because they have a track record of cash flow and management to report. Still other businesses may look at crowdfunding as an alternative to traditional lenders or investors.
This overview can help you determine which type of lending fits your small business — at any stage of its development.
Business credit cards
If your business needs less than $50,000 in capital and you can’t get a loan, credit cards may provide the cash infusion you need. According to the U.S. Small Business Administration, up to 65% of small businesses use a credit card regularly.
Consider getting a small business credit card (especially if your business is incorporated) to keep personal and business finances separate. A business credit card helps with recordkeeping by categorizing expenses, and it can help establish a good credit history for when your business seeks funding later.
Take advantage of perks and credit card rewards such as balance transfer deals, 0% introductory rates and credit cards that offer discounts for gas and office supplies, airline miles or cash back. But be aware that a long-running statement balance coupled with high interest rates can eat into your firm's profits. If you fall behind on payments, your credit can be damaged. Be sure to restrict your card use to essential business functions, and keep your balance at or below 30 percent of your credit limit.
Borrow from friends or family
Without an established business history, many startup business owners look to friends and family for initial funding. If possible, choose a friend or relative who can offer business guidance as well as cash. Prepare a business plan just as you would for any other business loan. Ask for just enough money to take the business to the next stage — and if you prove to your lender that you can repay on time, it will be easier to ask for more money later if you need it.
Websites such as Kickstarter and GoFundMe have demonstrated to entrepreneurs that small amounts from multiple funders can add up quickly. The crowdfunding model hinges on 2 methods to attract investors: The service or product must lend itself to a good story that contributors want to support, and the business seeking capital typically offers tiered rewards (such as free products and participation in product design) for each contribution level. Keep in mind that some crowdfunding sites void the funding offer unless you meet 100% of your goal, which means you won't receive any money, so make sure you understand all the terms and set a realistic fundraising target.
Line of credit
If your business has uneven cash flow, a line of credit can offer open-ended access to cash for ongoing needs such as seasonal payroll or inventory management. You must still qualify for the full amount requested, then you can borrow and repay funds during the term of the loan.
Remember, though: A line of credit isn't appropriate for long-term investments such as buying property or making large equipment purchases. Be prepared to submit detailed business financials, plus tax returns and bank account information, in order to secure the credit. An annual financial review is also typically required.
Small business loans
Small business lenders are generally more likely to provide a small business loan to businesses that have been in operation and profitable for at least 2 years. Small business owners will need to provide a broad range of documentation so the lender can analyze cash flow and the company's ability to repay the loan with interest. Here's what a lender will usually require before approving a small business loan:
- A strong, detailed business plan — including a solid budget supported by financial projections such as a profit-and-loss statement and a cash-flow statement
- The purpose of the loan, for example purchasing inventory or refinancing debt
- Past financial statements and your debt-to-equity ratio (your firm's liabilities shouldn't exceed 4 times the amount of your equity)
- Business and personal credit histories (the credit score for the business carries a little more weight, but both are important, especially for early-stage startups)
- Your personal equity investment (small business owners should have put in at least 20% of the total amount they're requesting)
- Personal guarantees from all principal owners (think about what assets you can put up as collateral)
- Personal background information on all business principals
How much do I need?
According to the Small Business Administration, the median small business loan in the banking industry is about $130,000. How much should you request? First, calculate the actual cost of what you're financing. Then project your monthly cash flow to see where you might need extra cash to tide you over. Also, keep in mind lenders may not finance 100% of the cost of new (or used) equipment.
Finally, consider whether the money you borrow will help you generate more revenue in the future. If not, you may be better off waiting. Consider leveraging any capital infusion you get into marketing and sales, with the goal of generating more money for the business in the long-term. That way, you may not need to borrow again (or as much) in the future.