Small Business Guides
How to raise money for your business: Part II
8 min read
So you’ve prepared yourself for the task of raising money in Part I of this guide – but now what? You’ll need to look at all the options to see which one suits your small business. So what are the best, most realistic ways to get funding?
Eight ways to raise funds
The traditional ways to raise money were through personal savings, bank loans or retirement funds. But now there's a much wider range of possible finance sources for your new business. So which type of funding is right for you?
1 Personal savings or retirement funds
If you have some savings you could use them to finance your business. The advantage here is you shouldn't have to pay interest on the money and you won't have an obligation to anyone else.
Using retirement funds is another option. It may be possible for you to draw down funds from your 401(k) to put into your business.
Regulations vary between countries, so you'll need to consult a financial adviser to see what's permitted. Be sure to check the tax implications of using personal savings or retirement funds for business purposes.
2 Bank loans and credit
Banks can be useful sources of funding, but the loans or credit they provide will usually have to be secured. That means you'll have to offer something of value as collateral. This could be your house, or your company's inventory or accounts receivable ledger.
If you fail to repay the loan, the bank may then take your collateral. That could mean you have to sell your house or stock, or lose your income. So it's not a transaction to enter into lightly.
Banks can offer the following funding services to help your company grow:
These provide a specific amount of credit to purchase assets or meet financing needs. The loan is repaid based on a predetermined schedule or through monthly principal and interest payments. Interest rates are usually fixed for the life of the loan.
- Lines of credit or business overdrafts
These tend to be used for periodic financing. You can borrow up to your credit limit whenever needed.
- Equipment financing
Buying equipment can be a good option if you expect it to have a long, useful life. You may also benefit from financial advantages such as depreciation and tax deductions.
- Real estate loans (mortgages)
These are loans for purchasing land or commercial property.
- Vehicle financing
This is usually for buying or leasing commercial vehicles such as trucks or company cars.
The authority to lend to businesses has become centralised in some countries. This leaves branch bank managers with less power than they had in the past. But you're still more likely to be given a loan if you have an existing account with the bank, since they can easily check your past financial record.
3 Credit card loans
Loans from credit card companies are usually unsecured, which means you won't lose your house if you fail to repay the loan (though you could still be declared bankrupt).
However, the lack of collateral is reflected in the price. Credit card loans can have a higher interest rate than other types of loan which are often much higher.
Ask yourself if your business can afford the interest rate being charged. If your company's profit margin is forecast to be 10% and the credit card interest rate is 15%, the numbers might not add up.
4 Government grants and small business loans
Many governments offer grants and loans to small businesses, either directly or through publicly funded organizations such as small business associations.
The available funds and the terminology will vary depending on the country you're in. Small business loans, microloans and research grants are often available for different types of business.
Your first step should be to contact small business organizations near you, since they will help administer government loans and grants. Talk to them and find out what financial assistance is available.
5 Venture capitalists and angel investors
Venture capitalist (VC) organizations became more prominent during the late 1990s dotcom boom, and the technology field is still one of their preferred areas of operation. VCs tend to favour high risk and high reward companies that have significant growth potential.
It's a gamble for them, but the payoffs can be significant. They usually demand significant equity in the company in return for funding, so be prepared to hand over a large percentage of ownership if you go down the VC route.
Angel investors are similar to VCs but they tend to work with companies that are at an earlier stage of development. The money comes from wealthy individuals, usually in exchange for convertible debt or ownership. A recent trend is for angel investors to participate in groups, working together on research, investment capital and advice.
Venture capitalists and angel investors will want you to answer the following questions in detail:
- How many customers do you have today and how do you plan to grow?
- When and how will your business be profitable?
- Who are the leaders in the company and what is their experience?
Don't be surprised if any funding deal includes sidelining you as executive manager or director. The VC or angel investor may not think you have the skills and experience to grow the company and repay their investment. If this is the case, they could want to replace you with someone who does.
“Don't be surprised if any funding deal includes sidelining you as executive manager or director.
Crowdfunding means getting finance from a large pool of backers. Instead of asking just one or two people for money, you can ask thousands or even millions. People pledge money in return for perks and rewards when your project goes ahead, and usually this is done online. Crucially, crowdfunding sites use an all-or-nothing funding model – either the funding goal is reached, or the project gets nothing.
Before you look at this as an option, make sure you get expert legal advice about your country's jurisdiction on crowdfunding.
If you are able to use crowdfunding, it offers an alternative to conventional funding, with less stringent credit checks, better-informed investors and often no need for collateral. And the funding process is often faster than it would be from a bank. This is a great option for some companies that will have struggled through recession and have poor credit ratings as a result, or others that are new and so have no credit record at all.
Crowdfunding can also provide useful feedback on your business plan. If you reach your funding goal, it's a good indication that your plan has a realistic chance of success. If you don't, you might need to rethink your plan.
Two of the most well known crowdfunding sites are Kickstarter and Indiegogo. The former is US focused while the latter is smaller but with more international support. If you want to use either of these crowdfunding sites, you'll need to check that they're available from your country.
For more about crowdfunding, here's a list of 30 people you might want to follow.
7 Peer-to-peer lenders
Similar to crowdfunding sites, peer-to-peer (P2P) lenders match borrowers and lenders directly. This is usually done via online auctions and without going through a traditional financial institution like a bank.
The rates can therefore be more favourable to both sides. Borrowers tend to pay less than bank lending rates, while lenders get a higher (though more risky) return on their savings.
While crowdfunding provides finance for new businesses or specific projects, peer-to-peer lending can be used for more general purposes.
It works a lot like eBay. You post the amount you need on a peer-to-peer lending site, along with the maximom interest rate you're willing to pay. Lenders can then choose how much to lend to you, and at what rate. Examples include Prosper in the US and Zopa in the UK.
Again, like crowdfunding, the jurisdiction in your country may prevent you from using P2P lending, so make sure you get legal advice before proceeding.
8 Friends and family
It can be tempting for you to borrow money from friends and family, but it can also go badly wrong. There's a simple psychological reason for that. Relationships are based on emotions, while business is (or should be) based on rational decisions. The two rarely mix well.
If you have a strong relationship with the friend or family member from whom you plan to borrow from, this can be a low cost source of finance for your business. But it can create an emotional liability as well as a financial one. This is the case particularly if you borrow from people who don't have much business experience.
If you do decide to borrow from friends or family, have a clearly written legal document explaining your agreement. That way, if there are any problems later on, at least you'll both have something in writing to refer to.
Adapt to the current financial climate
Banks are cautious about lending to small businesses at the moment. One reason for this is because they're rebuilding the capital they lost during the financial crisis. In addition to this, many of them don't understand the business models of some newer companies. They also tend to be more focused on real estate lending, because the collateral is tangible and fixed.
But low interest rates around the world mean that many cash-rich organizations and individuals are chasing yield. If you can present a compelling business plan, you stand a good chance of getting funding from less conventional sources.
Do your research to get the best option
Crowdfunding, peer-to-peer lending, government grants and loans, venture capitalists, angel investors and more offer plenty of possibilities. In fact, the funding landscape is changing all the time. For example, companies such as Kabbage offer working capital advances based on real-time business metrics.
Do your homework and use good quality accounting software to test out different financial scenarios, to see what funding your business really needs. Then compare the risks and benefits of the choice. Steer clear of disreputable lenders and make sure you understand the implications for your business. When you take your time and investigate all the funding options thoroughly, you'll find one that's right for your business.