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Today, small business owners have a number of options when it comes to obtaining financing to start or grow their business. Technology has offered entrepreneurs additional options for those in need of small business financing. But this has not always been the case. In years past, small business owners had very few options when it came to obtaining funding. The traditional way was to to apply for a bank loan which often was not approved.
The world has changed since the Great Recession and so has the small business financing sector. Prior to then we saw a rise in factoring and Merchant Cash Advances. Since the Great Recession an “alternative” lending space has evolved rapidly. In this post we cover some examples of small business financing options, both traditional and alternative.
Debt vs. Equity Financing
It’s important to understand that financing can be obtained in one of two ways: through debt (like a loans or other type of credit which must be repaid, usually with interest), or equity (issuing ownership in the business in exchange for financing). You can learn more about debt vs. equity financing here.
Amazon’s Alternative Lending Program
If you’re an aspiring entrepreneur in need of small business funding, you may want to consider selling your products through Amazon.com. According to the Wall Street Journal, Amazon Capital Services, Inc (a division of Amazon.com), has rolled out an alternative lending program for merchants who sell products through their marketplace. This gives entrepreneurs who may not be able to qualify for small business funding through traditional lenders an opportunity to fund their business using a viable alternative capital source.
Accounts Receivable Financing
Sometimes your customers simply don’t pay you soon enough while your employees, their payroll taxes and other vendors must be paid on a timely basis! If your business hasn’t been established or had a bad year, most banks and other lenders may turn you down for a line of credit. In such cases, obtaining cash based on your existing Accounts Receivable may be a good option for you.
Business credit cards are an easy way to obtain credit for your small business, and make it easy to track expenses while earning rewards for business expenses. It’s important to research several options before choosing the right fit, considering things like credit limits, rewards programs, fees, and of course, interest rates. Choosing a good fit could mean saving thousands of dollars a year in interest expenses and fees.
Banks and credit unions offer term loans, which are best-suited for long-term financing needs (in other words, if a business owner needs to finance the purchase of an investment or asset). In order for a business owner to qualify for a small business loan from a bank, they usually will need to meet minimum cash flow and collateral requirements, and have a good personal credit score.
For short-term needs, small business owners may consider a Line of Credit (LOC). These revolving loans make cash available on an as-needed basis, and can be used to cover working capital needs, like meeting payroll or paying invoices.
For business purposes, crowd funding is the practice of raising funds from donors for the purpose of launching or growing a business. This fundraising practice has been increasing in popularity in recent years, and generally obtains donations via websites like GoFundMe or Kickstarter.
Outside of small business loans granted by banks and credit unions, there are also other loan programs. These loan programs make financing available where it might otherwise be difficult or impossible for an entrepreneur or small business owner to obtain funding.
SBA Loan Programs
For example, the Small Business Administration (SBA) Loan program is ideal for businesses which do not meet the cash flow and collateral requirements for a traditional bank loan.
This program allows the SBA to provide a guarantee to the lending bank for the funds it lends to small business owners, which in turn reduces the risk for these banks. It is important to understand that SBA loans are not granted directly by the SBA, but instead by SBA-approved banks and financial institutions.
Learn more about SBA loans and other types of business lending here.
Venture capital is another popular method of obtaining funding, particularly for startups. Venture capital is a type of private equity, which is provided by venture capital firms to small businesses or startups that are believed to have high long-term growth potential. Venture capital firms evaluate the business model and the management team’s ability to scale-up with the assistance of its capital, advice, and business connections.
While venture capital can be a good fit for some businesses, it’s important to keep in mind that it’s not always the right choice for every business. If a deal seems to good to be true, it probably is. Be sure to take time to evaluate any venture capital offer and ensure that it makes good common sense!
Private Equity Groups
Today, there is an abundance of Private Equity Groups (PEGs) with capital to invest in growing, profitable, well-established businesses.
Private Equity firms typically seek businesses that demonstrate the ability to produce multiple years of EBITDA in excess of $500,000 (and some require much higher level of EBITDA). They also usually seek businesses which may complement other businesses they hold in its investment portfolio.
While some Private Equity Groups desire 100% ownership in its investments, many more desire continued ownership by the founder once the investment is made. The opportunity for a business owner to sell some or most of his/her equity now and then sell the remaining equity later, once additional growth in its value is achieved, is what makes sourcing Private Equity Group capital so interesting for many business owners.
Taking an investment from a Private Equity Group to grow a business, means the business may also benefit from the PEG’s investors, leaders and managements’ technical abilities, business acumen and connections.
Not all Private Equity Groups are alike. Each has its own unique set of investment criteria and goals. For the business owner who is considering a partial sale of equity to this type of capital source, careful evaluation should be made.
High net worth individuals (HNWIs) who invest in startups and high-growth small businesses (usually in emerging industries) are often known as ‘angel investors’. Angel investors are wealthy individuals who invest in high-risk, high-reward businesses based on their personal interests and beliefs about the business’ likelihood to succeed. Angel investors may come from a variety of backgrounds, and may have achieved wealth from a number of different sources, but often are entrepreneurs themselves.
In conclusion, if you are an entrepreneur or small business owner in need of funding, be sure to research your options so you can make the best decision for your personal circumstances and your business. Although it’s never been an easy proposition, there are more funding options available for your small business than ever before.