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Small Business Financing

Anne Miller

Anne Miller

Senior Author

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There are a number of reasons you may be looking to get financing for your small business. Whether you’re planning on opening a new company, or need to invest in expanding your current operations, financing is typically the most effective way to get the capital you need. The world of modern finance has provided countless solutions to funding your business – it’s all about finding the option that is best for your situation.

Many people don’t know how to obtain financing for a small business – they’re not sure if the process is separate from the consumer credit sphere. While it is mostly a different process, you should make keeping your personal credit score in good shape a priority – lenders may use it as part of the decision-making process.

You should remain aware of a few different things if you are considering financing your business. Don’t let a lowest interest rate offer result in you not considering other financing options. There are many different things that should go into the decision-making process when financing for a small business. Depending on the industry you’re in — term times, payment dates, and fees may have a large impact on the viability of your loan. You should make sure that the type of financing you receive is perfect for your business.

Traditional Financing Options for Small Businesses

If you find that you are ineligible for a particular form of finance, don’t let it discourage you. There are many different ways that you can fund you company. You will find that many lenders have specific requirements, and it would be impossible to be eligible for every form of credit. It is important to have a broad understanding of the different sources of small business financing – it is the best way to ensure that you are sourcing the right type of funding for your business.

This portion of our guide will overview the traditional ways that businesses finance their activities, both during and at the start of operations.

Traditional Business Loan

This is the most common form of business financing. Traditional business loans are typically provided by large lenders or banks. They provide you with a set amount of time that you have to pay back the loan (term) at a particular interest rate (APR). Most traditional business loans require collateral – many small business owners will sign over rights to the company or its assets in return for a traditional business loan. For this reason, it is considered a secured form of debt.

While having a secured loan may sound intimidating, it definitely has its benefits. Those who attain small business loans traditionally have much lower interest rates – hence their popularity. For this reason, it is recommended that you attain a traditional business loan for major purchases. In addition, this form of loan is the most common form of small business acquisition finance – those purchasing businesses for upfront capital tend to need lower interest rates than what other forms of finance can provide.

Revolving Forms of Business Finance

This is another form of traditional credit that many companies use to help finance parts of their business. Because it traditionally comes at a high interest rate, business owners often use it to fund smaller purchases. It is not advised that you use revolving credit to purchase or start a business – as the interest payments may be too hard to pay back.

Revolving credit is different from traditional loans in that it doesn’t require you to secure the debt against any form of asset. In addition, you don’t have to pay back the debt over a fixed term. Instead, you are offered a credit limit from which you can draw capital from – you don’t have to pay any interest on the money you don’t access, nor do you pay back any money you don’t use. For this reason, it is seen as a very flexible form of credit.

One of the most popular consumer versions of revolving credit is a credit card. In terms of small business, the two forms of revolving credit that are available are business credit cards and business lines of credit. An outline of each of these credit types is provided below.

Business Credit Card

Business credit cards have become increasingly popular in recent years, especially with business owners that have a number of employees. Like traditional credit cards, business credit cards are a form of revolving credit. They’re a great way to help finance ongoing costs in your business, as you don’t need to continue to reapply for credit every time you need more money.

In addition, many business owners use business credit cards to allow employees to make purchases on behalf of the business. This can greatly improve the efficiency of your business as you won’t have to constantly reimburse staff for purchases they make for the company. This is especially true for those who have a large employee base. As with all revolving forms of credit, business credit cards typically have high interest rates which make them an unaffordable form of credit for many large purchases. Another downside to business credit cards is that they typically charge high cash advance fees, meaning you won’t be able to use them for cash in your business.
Business Line of Credit

The second most popular form of revolving credit for small businesses is a business line of credit. This is similar to a credit card, but has some slight variations. With a line of credit, you don’t have a card attached to your limit, instead you have an account from which you can withdraw money or transfer people money. It is an attractive form of finance because it provides you with cash for unrestricted use.

Unlike business credit cards, business lines of credit give you cheap access to cash. But unfortunately, you will not be able to have a card facility to make purchases with, which can be inconvenient at times.

Alternative Financing for Small Businesses

If you feel that you don’t have substantial of enough credit to apply for traditional forms of finance, you may want to consider an alternative form of finance to help you meet your funding needs. This is especially true for people who may have a bad credit history, or don’t have enough assets to sign over as collateral. We’ve outlined the most popular forms of alternative financing for small businesses below.

Microloans

Microloans are a unique form alternative financing that are provided by various nonprofit community organizations. They provide their borrowers with a maximum of $50,000 – although the average loan is normally around $13,000. These microloans are supplied to community organizations by the United States Government Small Business Association (SBA). They are given with the purpose of helping small business owners finance their operations – they typically have very low interest rates. Some community organizations will have specific eligibility requirements, so make sure to check out their information before contacting them.

401k Small Business Financing

Using your 401k to finance your small business is a moderately complicated task, but it can be a great option if you find yourself unable to use other forms of finance. Many small business owners use their 401k to finance their businesses when interest rates are too high to justify using commercial lenders.

To use your 401k to finance your business, you need to understand the correct way to do it. First, you must set up a C Corporation. You then have this C Corporation retain stock but not issue it – then you transfer your 401k into the corporation. You shape it so the assets of the 401k can be used by the C Corporation. After this you begin to issue the total stock in the corporation to a profit-sharing plan in exchange for cash. It’s a creative way to get around the normal restrictions that your 401k has.

It must be stressed that while this is an affordable way to finance your business, it is also an extremely risky one. You are potentially putting your entire retirement at risk by using your 401k to finance a business. For this reason, you should never enter a risky business environment or risky industry if you’re planning on using your 401k to finance it.

Factoring

Factoring is considered finance by many business owners, but it more of a form of funding in reality. Many people refer to factoring as invoice financing for small business. We’ve mentioned it in this article because it is a common way that people attain credit for their companies. Factoring is a unique form of funding that allows you to take advantage of your business’ invoices without actually having to take on any debt. For this reason, it is considered an attractive option by many business owners.

Instead of taking out a loan, you can sell you invoices to a factoring company in exchange for upfront capital. They will then own the rights to collecting the invoice directly from your client. If you tend to work in a business environment where you are exposed to various seasonal gaps in cash flow, this can be a great option. Businesses often use factoring if they have clients who take considerable time to pay bills. Most factoring companies will give you up to 80% of an invoice upfront, it’s an awesome way to get funding without having to take on a liability on your balance sheet. The only downside to factoring is that your clients will know you are selling forward your invoices – this could potentially have a negative impact on your image

Small Business Financing Tips

If you’re looking for some advice on how to approach small business financing, the first thing you should do is make sure that you have enough time to make the right decision. The number one mistake that new business owners make is rushing to a decision over finance. By rushing into commitments that are not suited to your business, you’re making an active mistake that could end up costing you down the line. We’ve outlined a few more tips for financing small businesses below:

  • Don’t Use Unknown Lenders – One of the biggest mistakes new business owners make is using unknown lenders. You need to make sure that the lender you are using has an online presence so you can get a good idea of their track record – you’d be surprised about how horrible an experience can be if you use the wrong financier. Hidden costs and charges can surprise you if you’re not wary.
  • Avoid Personal Liability – This isn’t always doable, but you should attempt to avoid as much personal liability as possible. Some lenders may try and get you to sign over personal assets in order to secure loans, try and find a creditor who allows you to secure purely through business assets. This is another good reason that you should attempt to have capital to put down when you sign the loan – it reduces the likelihood that you will have to sign over personal assets.
  • Monitor Your Business Credit Score – Credit scores aren’t just for personal use, your business has one too. Make sure to make payments on time and monitor your score to make sure it’s correct. One of the best ways to save money financing your small business is to have a good business credit score. This is because lenders are more likely to offer you low-interest finance options if you have a good track record of borrowing.

In addition, always compare quotes between lenders. You need to ask prospective creditors questions upfront – if something seems off, make sure to speak up. In addition, ask for a full breakdown of the total cost of the loan. A loan may offer a lower interest rate, but this could end up being more expensive if there are hidden fees or administrative charges. If you ask for it, lenders will give you a full break down of every aspect of the loan, which will include a total cost of the financing – this is the figure that you want.

Remember – every business is different and has different financing needs. Don’t take someone else’s word for it, assess your business and determine the credit options that will allow for smooth business operations and maximum profit.

 

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