9 Types of Small Business Funding You Should Know
Securing the right funding option is crucial to a small business’ survival. The U.S. Bureau of Labour Statistics states that around 20% of startups don’t last longer than two years. One of the most common reasons for this is a need for more capital or limited financial resources.
If you’re considering starting a small business, knowing which type of funding you need launches your venture and keeps it running. In this article, we’ll be discussing why funding is vital in running a small business. Additionally, we’ll explore various small business funding options and how each of them can support your firm in the long run.
Why does a small business need funding?
Small businesses need funding for several reasons. For a business owner, it’s critical to determine what kind of financing your company requires so you can select the most valuable method specifically for you.
Startup costs
Starting a business comes with many initial expenses that can quickly become overwhelming. You need to purchase equipment, stock up on inventory, set up a physical location, and explore the need for a website. All of these business essentials are costly, and the funds aren’t immediately accessible for many small businesses. By securing enough financial support, you can cover these startup costs and give your company a strong foundation from the start.
Working capital
Businesses use working capital for daily expenses like employee salaries, inventory restocks, rent, and utility bills. All business firms, big or small, rely on working capital to keep things running smoothly. It also acts as a safety net during tough times. If your income slows down because of seasonal changes or unexpected expenses, you’ll need the extra funding to avoid operation disruptions.
Business growth
As your small business grows, you may need to hire more staff, expand to new locations, or upgrade your technology. Without enough financing, business firms can’t take these steps to survive in a cutthroat market. Getting financial support allows small businesses to explore new ideas and opportunities without putting too much pressure on their current resources.
Products and services
For businesses to stay competitive, they need to develop new products or services. This process often includes researching the market, creating prototypes, and launching effective marketing campaigns. Limited financial resources can set a small business back in its innovation goals. With proper financing, companies can invest in these areas and stay ahead of the competition while maintaining their financial stability.
Debt consolidation and restructuring
Many small businesses acquire debt from multiple loans or credit lines, making payment management challenging. However, by consolidating debt into one new loan with better terms, you can simplify your payments and reduce your interest rates. Similarly, restructuring existing debt can free up cash flow, ease financial stress, and give your small firm more flexibility to operate. Both funding options can help you regain control of your finances and set your company for long-term success.
9 Types of funding for small businesses
Each business has its unique financial needs and situations. What may be a great fit for one company isn’t necessarily the solution for yours. Luckily, there’s a range of funding options that can serve different purposes.
1. Small Business Administration (SBA) loans
An SBA loan is a government initiative intended to help small businesses access affordable financing. In this type of funding, the government guarantees a portion of the loan. This means there’s less risk for lenders, which allows them to offer flexible repayment terms and lower interest rates. For small business owners, this can be an ideal option to secure the funding they need without taking on too much financial burden.
There are several types of SBA loans tailored to different business needs:
- SBA 7(a) loans. These loans offer up to $5 million for a wide range of business purposes like working capital, equipment, and expansion.
- SBA Microloans. SBA Microloans offer up to $50,000 and are typically used for working capital or inventory and supplies purchases.
- SBA 504 loans. These are designed for buying major fixed assets such as real estate or equipment, helping small businesses grow, and creating jobs.
- SBA Express loans. SBA Express loans allow you to quickly borrow funds of up to $500,000 by using a term loan or a line of credit. The repayment terms range between 10-20 years, depending on what resources you need.
- SBA Disaster loans. These types of loans provide financial assistance for various emergencies, including natural disasters. You can take out a loan with the lowest amount of $100,000 and the highest being $2 million. Additionally, you can choose from four types of SBA Disaster loans:
- Home and personal property loans
- Business physical disaster loans
- Economic injury disaster loans (EIDL)
- Military reservists economic injury disaster loans (MREIDL)
- SBA Export Working Capital loans. With these loan programs, businesses can borrow additional working capital to finance their export sales. The highest amount for this loan is $5 million without a maximum interest rate limit. Thus, it’s up to lenders and borrowers to negotiate and reach an agreement.
- SBA Export Express loans. This loan is a fast solution intended for small businesses who plan to expand into the exporting industry. Borrowers can take out a loan of up to $500,000. Moreover, SBA guarantees lenders a portion of the loan if the debtor fails to repay the amount (90% for $350,000 or less and 75% for loans beyond $350,000.)
- SBA International Trade loans. This initiative was created to aid businesses in improving their competitive position in international trade. With a maximum loan amount of $5 million, entrepreneurs can modernize their facilities and equipment to create products and services that can penetrate foreign markets.
SBA loans are available to a wide range of businesses, including small businesses and minority-owned companies. The qualifications for this funding depend on factors such as the size of your business, how long you’ve been operating, and your credit history.
While SBA loans offer great benefits, they also come with some difficulties. The application process requires substantial paperwork and may take weeks or months to get approval. However, the lower interest rates and flexible terms make the wait worthwhile for many business owners.
Pros:
- Lower interest rates and longer repayment terms
- Backed by the government, reducing lender risk
- Available to a wide range of small businesses
Cons:
- Lengthy and paperwork-heavy approval process
- It may take time to receive funds
2. Personal funding or bootstrapping
Personal funding involves using your own savings or borrowing money from friends and family to fund your business. This approach is common for startup firms in their early stages when the initial costs are relatively low. By relying on personal funds or the support of close connections, you can avoid taking on traditional loans or giving up equity in your business.
Bootstrapping offers complete control over your company’s operations and growth since you’re not dealing with outside investors or lenders. Furthermore, you won’t need to think about monthly repayments or interest rates.
However, the downside to personal funding is its significant financial risk. Putting your own savings on the line could cause serious financial strain should your venture fail. Borrowing from friends and family can also add emotional pressure to your relationships if things don’t go smoothly. Thus, it’s essential to carefully consider how much you can afford to invest in your business financially and emotionally.
Pros:
- Full control over the business
- No need to repay loans or pay interest
- Flexibility in using the funds
Cons:
- High personal financial risk
- Potential strain on relationships with friends or family
3. Crowdfunding
Crowdfunding works by gathering small contributions from a large number of people. This is usually done through online platforms like Kickstarter or GoFundMe. With this method, startups appeal to a wide audience by offering rewards like special perks in exchange for funds.
This type of funding is perfect for creative projects, new products, or businesses with loyal patrons. It allows you to raise funds while also building a community of customers who believe in your vision. For instance, if you’re launching a new product, you can use crowdfunding to finance its development and build a solid customer base before it even hits the market.
Nevertheless, crowdfunding also has its difficulties. You’ll need to establish a website using a powerful website builder to create a strong online presence to reach as many people as you can. Having a website that embodies your business’ vision and story can entice your target market to fund your venture. To achieve that, you’ll have to run successful campaigns that require significant marketing and communication efforts. Additionally, crowdfunding doesn’t guarantee long-term financial stability because it’s generally used for one-time projects only.
Pros:
- No need to repay funds or give up equity
- Builds a reliable clientele
- Great for creative or unique products
Cons:
- Requires impactful marketing and engagement
- Success is not guaranteed, and you may not reach your funding goal
- Often a one-time funding source, not suitable for long-term financial needs
4. Business term loans
This type of loan provides a fixed amount of money that businesses can use for larger, one-time expenses. It comes with set repayment terms that will allow you to know how much your monthly payments are and when the loan will be completely paid off. In addition to that, interest rates are agreed upon upfront, so payments are predictable.
Term loans are best suited for established firms that have a solid financial history and are looking to cover significant costs without stretching their cash flow. However, these loans do come with some challenges. For you to qualify, lenders often require companies to have strong credit and healthy revenue.
Moreover, the size of the loan, interest rates, and whether you need to provide collateral can vary depending on your financial situation and the lender’s requirements. For startup businesses or those with lower credit scores, securing this type of loan may be more difficult.
Pros:
- Predictable monthly payments
- Fixed interest rates
- Can fund large expenses
Cons:
- Higher credit and revenue requirements
- May require collateral
5. Line of credit
A line of credit is a flexible form of funding that allows businesses to borrow money as needed, up to a set limit. Compared to a business term loan, where you receive a lump sum, a line of credit functions more like a credit card. You can use it whenever you need financial resources and only pay interest on the amount you spend. After repayment, the credit becomes available again, giving your company constant access to funds.
Business credit cards are best for covering short-term expenses like managing seasonal fluctuations, unexpected costs, or cash flow gaps. For example, if you need to buy inventory ahead of a busy season or cover payroll during slower periods, a line of credit can provide a quick boost to your business needs.
Having a line of credit offers flexibility and convenience, but it often comes with higher interest rates than traditional business loans. It’s crucial to use this option carefully, as the costs can add up quickly if you carry a balance over time. Additionally, the amount you can borrow may depend on your ability to pay it back and the financial health of your business. This makes it more difficult for newer or smaller firms to qualify for a large credit limit.
Pros:
- Flexible borrowing as needed
- Only pay interest on what you use
- It can be reused once it’s repaid
Cons:
- Higher interest rates than traditional loans
- Credit limit depends on your business’ financial health
6. Invoice financing and factoring
Invoice financing and factoring allow you to acquire funds using unpaid customer invoices.
Invoice financing
Businesses use invoice financing to borrow money against their customers’ outstanding bills. If you’re waiting on payments from clients but need money now, invoice financing can provide a short-term solution. Essentially, the lender lets you borrow around 80%-90% of the invoice amount. Then, when the invoice is paid, you repay the loan, including fees and interest.
This option is ideal for companies with a steady flow of invoices that are often paid late. It’s a way to unlock funds that are stuck in unpaid invoices without waiting for clients to settle their bills.
Pros:
- Instant cash source without waiting for customer payments
- No need to sell ownership or collateral (other than invoices)
- Great for maintaining cash flow during slow payment periods
Cons:
- Fees and interest can add up, reducing overall profit
- Approval may still depend on your credit history
- Risky if customers are late on payments or fail to do so
Invoice factoring
On the other hand, invoice factoring involves selling unsettled invoices to a factoring company at a discount. Instead of borrowing money, the factoring company buys the invoices for around 70%–90% of the amount. When the invoice is settled, the factoring company keeps the rest, minus their fees.
Invoice factoring is best for firms that need immediate cash and can no longer wait for full payments. It provides quick access to funds but comes at the cost of reduced revenue because of factoring fees.
Pros:
- Immediate cash without taking on debt
- Great for businesses with large outstanding invoices
- No need to wait for customer payments
Cons:
- Fees reduce the total amount you receive
- May impact customer relationships, as the factoring company handles the collection process
7. Equipment financing
Equipment financing is a type of funding you use to purchase or lease machinery like computers or vehicles for your business. This type of funding works best for businesses that rely on costly equipment for their operations. Instead of initially paying a large amount, equipment financing allows you to quickly get what you need while preserving your existing resources.
One of the biggest benefits of equipment funding is its fast approval process. This is because when the equipment serves as the collateral itself, lenders consider it a low-risk option. Nonetheless, the downside of equipment financing is its scope. This means you can’t use the funds for other business expenses.
Pros:
- The equipment serves as collateral, making it easier to secure
- Fast approval compared to other loan options
- Helps businesses acquire essential equipment without draining initial funds
Cons:
- Funds can only be used for equipment purchases
- You may be responsible for repairs and maintenance
- If you fail to repay the loan, the lender can seize the equipment
8. Merchant cash advance (MCA)
A merchant cash advance (MCA) allows companies to borrow money based on their future sales. Typically, the loan is repaid through a percentage of daily credit card transactions. Unlike other kinds of loans, MCAs don’t have fixed monthly payments or a set interest rate. Instead, your repayment adjusts according to your daily sales.
This method of funding is intended for businesses that have a constant stream of credit card sales. It offers an instant solution when you need immediate funds for operation expenses. Firms can often receive cash only within a few days. However, this convenience comes at a cost, as MCAs usually carry much higher fees. In addition to that, the repayment process can also take a significant portion of your daily revenue.
Pros:
- Quick access to capital
- Repayment is flexible and depends on daily credit card sales
- No need for strong credit or collateral
Cons:
- High fees
- Repayments can reduce daily cash flow
- Not ideal for businesses without consistent credit card transactions
9. Equity financing
Equity financing deals with raising capital by selling ownership shares in your business to investors. You’re basically giving up a portion of your company in exchange for the funds needed to grow. This approach is popular among startups that are looking to scale quickly and need substantial investment to do so. It’s often used by businesses in industries like technology or biotech, where rapid growth is essential for thriving.
The most common sources of equity financing are angel investors, venture capital firms, and other private investors. Venture capitalists provide substantial capital to companies with promising potential in exchange for equity. Angel investors, on the other hand, are individuals who provide smaller amounts of capital, often in the early stages of a business. Both types of investors usually want a say in major business decisions because they have a stake in the company’s success.
One of the key benefits of this type of funding is that there’s no need to repay the money. This means you’re not taking on debt or dealing with interest payments, but you’re focusing on growing your venture instead. Though, the disadvantage is that you’re giving up partial control of your company. Investors may have an influence on how the business is operated.
Pros:
- No debt or loan repayments
- Can raise significant resources to fuel rapid growth
- Access to experienced investors who can mentor you
Cons:
- Owners lose partial control and decision-making power
- Investors expect a return on their investment
- Equity financing divides ownership, thus reducing your share of profits
Ready to fund and launch your small business?
Funding is essential to launch and maintain a small business. Since many companies have different needs, there are several funding choices available. One can apply for an SBA loan, which provides low interest rates and long repayment terms. You can also opt for bootstrapping if you prefer avoiding loans and maintaining full control over your business. In essence, it’s critical to learn about what your company needs so that you can make an informed decision.
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Frequently asked questions (FAQs)
The best business type for a small business depends on your goals, industry, and how much liability protection you need. For many small businesses, a limited liability company (LLC) strikes a good balance between an easy setup and liability protection.
The most profitable small businesses often have low initial costs and high demand for their services or products. Some of the most profitable types include:
•eCommerce
•Consulting and coaching
•Home improvement services
•Health and wellness
According to the Small Business Administration (SBA), small businesses are defined based on their number of employees and their annual revenue. Generally, you’re considered a small business if you have less than 500 employees and earn an annual revenue of under $7.5 million.
For beginners, the best businesses are usually those with simple operations, minimal startup costs, and the ability to maximize existing skills. A few options include:
•Freelancing. Offering services like writing, graphic design, or web development allows you to start with minimal investment.
•Dropshipping. Selling products online without holding inventory is a low-risk way to enter eCommerce.
•Tutoring or teaching. If you have expertise in a subject, offering tutoring services online or locally is easy to start and scale.
•Pet services. Pet sitting, dog walking, or grooming require low investment and have steady demand.