Business lender shaking hands with entrepreneur
There are more ways than ever to fund a small business. Find the one that makes the most sense for your needs. — Getty Images/ fizkes

With many new and established businesses struggling to make ends meet during the COVID-19 pandemic, it might make sense to consider new funding sources to get through these challenging times. If you do decide you need more funding for an existing business or funding to start a business in the first place, you might assume you need to take out a traditional bank loan.

However, there are many options for small business funding, and some will make more sense than others, based on

  • if you’re starting a new business;
  • if you're growing an existing business;
  • your credit history;
  • your revenues; and
  • the goals you’re trying to accomplish.

To help you understand how to fund a small business, this guide will

  • detail how much your small business may need to get started;
  • outline funding options;
  • discuss how to secure that funding; and
  • walk through what to consider when selecting a funding option.

Startup necessities

You should go into seeking funding for a new business armed with some information. First, decide what’s on your "need" list and what’s on your "it can wait" list. Pose the question this way: What is the bare minimum required you need to get your venture off the ground?

At the same time, you can’t skimp on the necessities. This will, of course, be a major investment. So, if — when thinking through your new business venture — you put something on the “it can wait” list, check with other areas that may be affected if that area doesn’t get funded.

Here are some common business expenses and the questions surrounding them to consider before trying to secure funding:

  • Payroll — How many employees do you have, what are you paying them, and how many employees will you have in the next six months? Startup and small businesses don’t always stay small, so think about how many people you will need to start, but also how many you may need before you start making a profit. Also, consider how you’re going to pay yourself. As the founder of the small business, you need to live, too.
  • Insurance — Is your business prepared if disaster strikes? Will you be offering health insurance to your employees?
  • Licensing, permits and taxes — Doing business costs money and you want to make sure you won’t be running into any legal trouble. How much capital do you need to cover licenses, permits and taxes?
  • Rent and utilities — If you’re moving your business into a physical space, make sure you can afford your lease and utility costs to keep things running. Make sure you clearly understand the terms of a commercial lease before signing a contract.
  • Equipment — Do you need computers, phones, machinery or other forms of equipment? Is renting or leasing equipment a possibility? Can you get equipment used? How much personal protective equipment (PPE) do you need to buy to protect worker and/or customer health?
  • Inventory and upcoming orders — Do you have enough raw product to make your business continue to operate? If you don’t, should you be investing in more?
  • Advertising and website — You have to let people know you exist, and this doesn’t happen without advertising and a good website. Perhaps you will buy social media ads, rent billboards, put an ad in a local magazine or optimize your site for the best search engine results. All of this costs money.
  • All the extras — Will you or your employees need to travel? Are there consultants in your field you should pay for some advice? Will you need a lawyer on retainer or to handle any sort of small business matter such as obtaining a copyright or trademark?

There is no "right" way to fund your business, whether you’re looking for startup funding or to maintain or grow your existing business.

Types of small business funding

There is no "right" way to fund your business, whether you’re looking for startup funding or to maintain or grow your existing business. Some types of funding work better for different stages of your business, and sometimes the right answer might be a combination of funding types.

Here are some common ways to fund your business:

Traditional loans — If you are a new business, you might not have a credit history. In that case, traditional lenders will look at your personal credit when deciding whether to give you a loan. Your credit history is the track record of how promptly you pay your bills and is used to determine how risky it is to lend to you. Traditional lenders, like banks, are cautious with their money. If your credit score is below 680, there may not be many options for you in the traditional lending arena. On the other hand, if your business is more established (two years in operation or more), and you have good credit and at least $100,000 a year in revenue, you’ll probably find very good interest rates from a traditional lender.

Online lenders — If your credit score isn’t up to par or you don’t have much time in business, you might look at popular online lenders for a loan. According to a recent Small Business Credit Survey by the Federal Reserve, 22% of the businesses surveyed applied for funds through online lenders.

Personal loans — If you have a new business, but your personal credit score is high, you might consider taking out a personal loan for funding. Be aware, though, that if your business fails, this will seriously impact your personal credit.

Microlenders — As the name suggests, a microloan is a very small loan, typically of less than $50,000 given out by individuals rather than traditional lending institutions. These loans may also be offered through government organizations such as the Small Business Administration (SBA) or nonprofits. If you don’t need to borrow a lot of money, this could be a good direction.

Small business grants — Many government entities, corporations and nonprofits offer money for people to launch or grow small businesses. Some small business grants are open to any small business while others are targeted to specific demographics, like businesses owned by minorities, women or veterans. The website also serves the role as the largest database for federal grant opportunities.

Self-funding — You might be surprised by what you can do on a limited budget. Bootstrapping your own business can pay off down the road if you want to apply for a loan because it shows perseverance and dedication. The big question is whether you can afford to invest your own money and if it’s enough to accomplish your goals.

Investors — Are you involved in your local entrepreneurial community? It can be a good place to find people willing to invest in your business and ideas. Diligently research any investors and venture capitalists and work to come to an agreement on a term sheet about your business arrangement.

Crowdfunding — Crowdfunding will require you to pitch your business idea online through popular sites such as Kickstarter or Indiegogo to get up-front pledges to fund the business or product. However, you have to know how to market yourself and be savvy with web content for these options to work.

Friends and family — This can be a risky way to fund a business, but if you treat the situation professionally, it might work out. Friends or family helping to fund your business should earn interest or equity in the company and should be given monthly payments. Paperwork should still be drawn up.

Invoice factoring — When a business sells its outstanding invoices to a factoring company, it is called invoice factoring. An invoice factoring company quickly repays the business a percentage of what the invoice is worth, usually between 75% and 90%. Once the full invoice is paid, the factoring company pays your business the remainder of the invoice while subtracting their factoring charge and a factoring fee. This isn’t a loan, but it can help companies cover cash flow issues. Because it isn’t a loan, whether a factoring company will work with your small business or not is not as dependent on your credit score, but rather on the credit scores of your clients who they are depending on to pay in a timely fashion.

Ways to make your business attractive to investors and creditors

Writing a robust business plan is a good way to present your small business to banks and potential investors. It should include your personal story and be able to convey your passion for your small business.

The business plan will require you to do a fair amount of market research and convey that you understand the industry in which you are entering and the direction in which you want to take your business. Back up your financial projections with data. A business plan should also include a clear business model as well as a marketing plan. Also keep in mind that the COVID-19 pandemic has also changed business plans.

Before you apply for funding from a traditional lender, and even some online lenders, it is crucial you know your business credit score as well as your personal credit score. If they aren’t up to snuff, take steps to raise them such as by paying down debt or removing any incorrect derogatory items.

Selecting a route to fund your business

Answering questions about your business and how you plan to use the financing is a good way to know which direction to take to fund your business. You should be able to answer the following:

  • How much money do you need, and what do you need it for?
  • How much debt can you afford to take on?
  • What is your preferred method of borrowing money?
  • Are there any changes you need to make to be eligible for that type of funding?
  • Do you have a good personal credit score?
  • How long have you been in business?
  • What are your revenues?
  • Do you have any collateral?
  • Does your story and business idea seem like something you could take to an investor?
  • Have you established a solid enough business plan to talk to an investor or a traditional bank?

The goal of any type of funding should be to benefit your business, not saddle you with debt. So, it’s wise to choose a funding type that best fits your financial needs and will help you reach your business goals.

CO— aims to bring you inspiration from leading respected experts. However, before making any business decision, you should consult a professional who can advise you based on your individual situation.

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Published September 15, 2020