If you’re considering ways to finance your small business, this guide will help you understand the types of small business finance available to you, what risks to prepare for, and – ultimately – which SME financing approach may be best for you.
Loans are the most traditional form of small business finance, though the internet has brought about a host of new financing methods, including crowdfunding and peer-to-peer funding.
Generally speaking, small business finance breaks down into two categories: debt and equity. Debt financing covers options such as secured and unsecured. On the other hand, equity funding tends to come through outside investment (from angels or venture capitalists). Which route is right for your business will depend on a number of factors.
But before we dive any deeper into the different types of SME business finance, there’s a higher-level question that’s important to ask: :
Small business finance comes at a cost – either in the form of a debt or loss of equity and it is important to understand each form has its pros and cons. Indeed, either may be better to forgo altogether and bootstrap the business with profits. Growth may be slower, but debt financing costs and loss of equity have come back to haunt many business owners.
Just remember: debt and equity financing is not the only option for funding your small business. Further on in the guide we’ll also discuss family loans and business grants, both of which are good alternatives to consider.
Secured loans are loans that use one or more of your assets as collateral such as vehicles, inventory, equipment, etc. They could also be secured against future income from card spending as in merchant cash advances or from invoices you have outstanding as is the case for invoice financing. The finance could alsoIf you fail to repay a secured loan, the agreed-upon collateral can be seized and sold by your lender to make up for their losses.
An unsecured loan is the opposite of a secured loan. There is no collateral, so a lender can’t seize any of your assets in the event that you don’t repay. Obviously, this takes some of the stress out of borrowing, but it also means that the pool of lenders is going to be a little smaller. Plus, unsecured SME loans tend to have higher interest rates, and smaller loan amounts, to help protect the lender.
If invoices are a component of your business model, this is a great way to bring in extra cash. Invoice financing is when you take an unpaid invoice and show it to a lender, who then pays you a percentage of the amount on the invoice.
Business Grants are more or less free money from certain institutions, typically the government. So long as you meet the qualifications for a grant, you’re eligible to a sum of cash, no strings attached.
You may have heard of ‘crowdfunding’ in the context of Kickstarter or Indiegogo, where ‘backers’ invest in a new idea with the promise of receiving first access to, or discounts on, the goods upon launch. However, we’d like to draw your attention to a slightly more business-appropriate means of crowdfunding.
Crowdfunding is a relatively new form of small business financing that uses campaigns to generate funding. If you have an idea that can excite the masses, you can call on their support and receive donations to bring your idea to fruition.
Business angels, also known as angel investors, are wealthy individuals who invest in new businesses they believe in. In exchange for their support, startups offer them a share in the business.
Venture capitalists are like angel investors, except much more serious. These are individuals who, if the right idea crosses their path, are willing to offer large sums of money in exchange for a large percentage of your business.
For early stage startups, incubators and accelerators can be the golden ticket to commercial success. Being involved in either an incubator — a sort of co-working space, with access to expert mentors and advisors — or an accelerator — typically an intensive development workshop, lasting a few weeks or months — can provide the resources, training and exposure needed to establish a viable business model.
Many of these programs also offer equity-based funding, to spend on building the business up.
Seed Enterprise Investment Schemes (SEIS) and Enterprise Investment Schemes (EIS) are investment schemes specifically designed to attract investors to small or medium sized businesses. They do so by offering tax reliefs to individuals who buy shares in the SME.
The amount of relief varies between SEIS and EIS, but these routes typically offer a win-win scenario for SMEs and investors alike.
Any time you borrow money from anybody, in any form, you take on risk.
The size of that risk will depend on the type of small business financing you acquire, how much you borrow, and how you spend the incoming cash.
If you’re strategic about how you borrow, you can help mitigate the fallout — even if the worst happens and your business goes under. Be realistic about your business’s chances of success, and the amount of revenue it will generate, and only borrow money that will increase your potential revenue.
Some of the financing sources mentioned above (family loans and crowdfunding) can be used by anyone, while others have stricter requirements. That being said, any small business should be able to find some source of initial capital, it’s just about knowing what you qualify for.
For secured and unsecured loans, you’ll need a solid credit score, specific documentation, a clear business plan, and possibly collateral. Grants will all have unique requirements depending on the type of business you run, while individual investors will have personal criteria that they check for. It all comes down to researching your prospective sources of funding.
There are several types of financing for small businesses, including secured and unsecured loans, investments from angel investors and venture capitalists, and loans from friends and family.
You can! Though there are sometimes strict requirements and long wait times in order to be approved, many new businesses do qualify for grants. To shorten your waiting time, make sure that you are able to provide the qualifications requested.
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