Introduction to business lending options for small and medium sized businesses.
Making sense of business funding can be tricky, so we put together this in-depth guide to help you make the right choice for your business. Here in this free online guide, you will find a comprehensive review of the pros and cons of the most common small business financing options. Chances are that you already know and may have even considered some of these business funding options.
Use the Table of Contents to jump to the section you're most curious about. Before we jump into the guide, though, let's address up front the most common questions that business owners ask when researching and choosing business funding.
Top Questions When Choosing Business Funding
Are they going to pull my credit score?
Even though you're looking for funding for your small business, a lot of financial products rely on your personal credit to approve you, and to penalize you by reporting issues back to the credit bureaus if you don't pay them back on time. This includes products like lines of credit, invoice factoring, and term loans.
Are they going to contact my customers?
Some options, like invoice factoring, give you money up front for unpaid invoices, but then require your customers to pay them back directly—not you. Some small businesses don’t mind someone else making contact with their customers, but others don’t want a third party interfering with their customer relationships because it could lead to an uncomfortable conversation with the customer.
Are they giving me more money than I need?
This might sound like a good problem to have, but think about it this way: if you get a huge term loan for more money than you need, you still will have to pay interest on the entire amount, not just what you use. That can add up to a lot of unnecessary interest payments.
Do they charge a lot in fees?
Keep an eye out for things like origination fees, subscription fees, maintenance fees, and prepayment penalties. These fees are often tacked on in addition to the interest rate and might be covered only in the fine print.
Will I get into a debt spiral?
Some financial products allow you to extend your debt past the final term period. Usually these products add fees to the interest you already owe, which can create an ever-increasing debt that can be very hard to pay down.
Traditional Bank Loans
When a small business owner needed money in the past, they would head over to the nearest bank, talk to an agent, and sign a loan agreement shortly thereafter. In return, they’d get the money they needed to grow their business with a low, fixed interest rate. They’d know exactly how much money the lender expected them to repay each month. Over time, they’d develop strong relationships with their bankers—something that’s certainly nice for any small business owner to have.
Unfortunately, banks have tightened their lending criteria significantly in the wake of the 2008 financial crisis. While approval rates have increased slightly in recent months, big banks only sign off on about 25% of the small business loan applications that come their way. Generally speaking, the companies they end up funding have very strong financials and near-perfect credit scores.
What ends up happening is that a majority of small business owners may end up having to jump through many hoops and fill out a ton of paperwork, only to ultimately find out the bank rejected their applications.
Those lucky enough to get approved may even discover they need to wait anywhere from a week to a few months to get funded—and they might also need to put up collateral to obtain financing.
Unless you’re okay with lots of paperwork, a personal credit check, and potentially losing some of your property in the unfortunate event that you can’t make your loan payments—and you have several days or weeks to spare until money comes your way, assuming you do get approved—a different financial vehicle may make more sense for your business.
Low interest rates
Bigger loan amounts
Fixed monthly payments
Develop a strong relationship with the bank
Strict credit requirements
May require collateral
Banks lend to established businesses (not new ones)
Business Lines of Credit
A business line of credit is a revolving line of capital that can be used to grow your business when you need it. With a traditional term loan, for example, $100,000, you’d get the money all in one lump sum. On the other hand, if you were approved for a $100,000 credit line, you would be entitled to withdraw up to that amount of money as you need it.
Business lines of credit tend to have high interest rates; companies with poor credit scores can still qualify for this type of small business financing, but they will likely have to pay even higher interest rates. You may also run into additional fees associated with establishing and maintaining these credit lines, but you’ll typically only have to pay interest on the amount of money you spend—not the full amount of your credit line. Depending on the size of the credit line, you may also need to put up collateral to get approved.
In addition to their costs, lines of credit also carry significant risk. If you max out your line of credit and your business can’t repay it, in many cases, you are personally liable for the debt.
Only pay interest on what you spend
Very high interest rates
Often requires a personal guarantee
Often requires a hard pull of your personal credit, which may lower your credit score
Significant risks if you can’t repay
Merchant Cash Advances
If your business processes a lot of credit card transactions, a merchant cash advance may be the type of financial instrument you need. Merchant cash advance lenders give small businesses money in exchange for a percentage of their future credit card receipts. For example, you might get an advance of $50,000 in exchange for giving the lender 10% of your monthly credit card purchases until you have repaid that debt, plus fees. Advances are typically short-term loans that you repay within 12 months.
Assuming you meet the threshold for credit card sales, a merchant cash advance is one of the easiest and fastest forms of small business funding to obtain—even if you have bad credit. Many people consider this type of funding because you can get the cash within a week, without too much paperwork, and because these advances are unsecured, meaning that you won’t have to put up any collateral. Since the amount you pay back depends on a percentage of your credit card receipts instead of a fixed amount, you won’t have to worry about being unable repay a monthly installment.
While merchant cash advances are quick, they can be quite expensive In fact, by one estimate, the fees tacked on to these financial instruments can reach as high as a 60%–200% annual percentage rate (APR).
No fixed monthly installments
Available even if you have poor credit
High fees when compared to bank loans
Temporary fix to business problems
Daily deduction from your sales means ongoing cash flow reductions
Loans from the Small Business Administration
The Small Business Administration (SBA) guarantees some loans, issued by banks and other lenders, to small businesses. Because of these guarantees, lenders are typically more willing to take on riskier loans and may fund entrepreneurs with little business experience and suboptimal or nonexistent credit.
While SBA loans typically have low interest rates and long repayment terms, small business owners must meet strict requirements to qualify for one. Typically, you will have to fill out mountains of paperwork to apply. You will need to provide proof of at least 2 years in business, as well as good personal and business credit. You can find out more details about the eligibility requirements for SBA loans here, or see our in-depth guide to SBA loans.
If you apply for an SBA loan, you should be prepared to wait several weeks before you learn whether you are approved. Most SBA loans require you to put up collateral, too.
Low interest rates
Long repayment terms
New businesses can get funded
Long application process
Strict eligibility and approval requirements
Increasingly, small business owners and entrepreneurs are turning to crowdfunding sites like Kickstarter and Indiegogo to raise money to grow their companies. In crowdfunding, customers pledge money to up-and-coming businesses in exchange for certain rewards. The more money customers pledge, the bigger the reward. Learning how to make more money with customers' money is key.
On the plus side, small businesses owners that go this route can get the money they need without incurring too much risk by paying for materials up front, or giving up any equity to investors. Build the right kind of campaign and you can also benefit from a ton of exposure via sharing on social media. Suddenly what seemed like a small idea might turn into a very big one. (Just ask the famous potato salad guy.)
Crowdfunding, however, is not without its risks. Even if you do succeed, you’ll have to pay several fees—both to the crowdfunding platform and to credit card companies. Due to the open nature of crowdfunding, someone else who stumbles across your pitch might decide to copy your idea. Additionally, you may end up spending a lot of time creating content only to fall short of your fundraising goal—and end up not getting a penny.
Pre-fund new products with pledged money
Don’t have to sell equity
Don’t have to take on long-term debt
Your campaign could go viral
Most campaigns are very time-consuming
Potential for plagiarism or intellectual property issues
Borrowing from friends and family
Some small business owners who need money turn to their families and friends to see what they can scrape together. When you secure financing this way, you’re likely to get very flexible repayment terms and much lower interest rates.
Depending on how much money you need, however, your friends and family might not be able to help. Even if they can help, you might not always want that help. It can be a delicate matter to deal with a loved one who feels entitled to impose their opinions about how you should run your business because of their investment. There’s always the uncomfortable possibility of strain or friction in your relationships with any loved ones who lent you money. Before borrowing money from friends or family, it’s a good idea to ask yourself, How can I protect this relationship if something goes wrong, if we have a disagreement, or if I cannot pay back what I borrowed?
Flexible repayment terms
Low interest rates
Might not be able to raise enough money
Family and friends might get involved with your business
Potential harm to your relationship if you’re unable to repay
You might think that grants are just for nonprofits or students, but there are many grants available for small business funding if you know where to look. No matter what type of business you run, there’s a chance that you have a chance at some grant money. Federal agencies, state agencies and private companies all offer grants to small business owners and individual entrepreneurs.
If you apply for and are selected for a business grant, there are a lot of upsides. First, since a grant isn’t a loan, you don’t need to pay it back. Usually, a grant comes in the form of a lump sum payment to the winning organization or individual. You won’t need to worry about things like interest or repayment terms, since it’s closer to a gift (with some limitations) than a loan.
Grants might sound like “free” money but of course, there’s no such thing. Even if you are eventually selected for a grant, with no application fees, you will definitely need to spend valuable time searching for grant opportunities, evaluating whether they are a good match for your business, and writing the applications. Since large or prestigious grants attract many applicants, it can get quite competitive. You might also encounter restrictions on how you may use the money if you do get selected. Many grants have strict limitations on the types of uses they allow for the funds. If you don’t stay within the usage guidelines, you could end up having to pay the grant money back.
For more information about grants and the most common industry grants that SMB’s should know, check out our guide here. For more information about grant-making government agencies, check out grants.gov. Or, check out this roundup of over 100 small business grants.
Not a loan so no need to repay
No risk to apply
The only cost is your time
Large grants are very competitive so you can’t count on winning
Time consuming research and application process
Restrictions and rules about how you may use the funds
For some small business owners who are short on cash, it may make sense to sell an equity stake to a venture capitalist or angel investor. Though you have to give up some ownership, your investors may be able to give you valuable advice on what it takes to get your company to the next level. If you choose this route, there’s nothing to repay in the event your business doesn’t succeed.
On the other hand, when you sell equity, you’re giving up some ownership of your company, which means that your financial upside will be capped. You may also end up with an investor who prefers taking an active role in the companies they fund—leaving you with less control over the business you built. Additionally, It may take quite a while to find the right investor.
No monthly repayments
Knowledgeable business partners
Less control of your company
Some companies that need small business funding but have a lot of money tied up in accounts receivables opt to get the cash they need through invoice factoring.
Factoring is the process of selling your outstanding invoices to a third party in exchange for immediate cash. Typically, you’ll get anywhere from 70%–85% of an advance right away–without having to put up any collateral. Say goodbye to spending tons of time tracking down payments and asking customers where their checks are.
While factoring may be faster than some other financing options, it can be quite expensive. It’s not uncommon for companies to forego 20% or even more of the cash they’re owed in exchange for fast money. What’s more, factoring companies end up collecting payments directly from your customers—which may damage your relationship with them. Additionally, factoring companies may prevent you from doing business with customers who they deem unlikely to repay. Another thing to consider is that factoring companies often require a long-term agreement, locking you in to working with them for a large portion, or all, of your invoices.
Potential long term agreements
Invoice financing with Fundbox
Instead of selling invoices to factoring companies, small businesses with unpaid invoices can also use invoice financing to borrow against their own receivables.
Here’s how it works: Connect your accounting software to Fundbox so we can evaluate your business based on the data in your accounting software. If approved for credit, you can choose which invoices you want to clear, within your credit limit, and voila, money will be transferred to your account in as soon as one business day. Payment plans are either 12 or 24 weeks, your choice, and there is no penalty for repaying early. In fact if you chose to repay early, Fundbox will waive all remaining fees.If you finance your invoices with Fundbox, the fees are flat, so you’ll always know what you will owe, before you draw funds.
Since you are only able to draw funds based on your outstanding accounts receivable, you may be limited in the amount of funds you can draw at a time. Unlike factoring, though, invoice financing with Fundbox provides small businesses with the full value of their unpaid invoices, so you won’t have to worry about only getting a percentage of the invoice you’re owed. With invoice financing, money is available quickly, too; with Fundbox, you can have access to your funds in as fast as one business day. Customers still pay your company directly, so Fundbox won’t interfere with your relationship with your customers.
While there are still costs associated with invoice financing, they’re typically more transparent and easier to understand and predict than factoring expenses. If you’re using Fundbox and you’re able to repay the advance sooner than it’s due, we waive any remaining fees, which saves you money.
Fast business funding
Solve cash flow problems
Get the full value of your invoices
Transparent fees (with an option to save when you repay early)
Must have at least 6 months invoicing history in your accounting software
Must have at least $50,000 in annual revenue
Manage Your Accounts Receivable with Fundbox Pay
Issuing invoices often means waiting to get paid. The bigger your accounts receivable (A/R), or the longer it takes for your A/R to turn into cash on hand, the harder it is to manage your cash flow and grow your business. Rather than borrowing money, use Fundbox Pay, a financial product that lets your business get paid right away while extending Net terms and financing to your business customers.
Think of it this way: When you order a latte at your neighborhood coffee shop, the barista makes your coffee and you swipe your credit card. The coffee shop gets paid right then and there (less a credit card processing fee), and you get your caffeine without really paying for it. You’ll have to pay for it eventually–either on your next credit card statement, or if you really wanted to, you could finance that cup over 2 years. You and the coffee shop both get what you want: credit on a purchase (for you, the buyer) and immediate payment (for the coffee shop, the seller).
Today, however, most businesses that sell to other businesses have to choose either to get paid up front or extend terms so their buyers can afford to purchase. With Fundbox Pay, your business doesn’t have to choose. Learn how it works.
Get paid right away and chop away at your A/R
Manage the overhead of offering trade credit
Buyers must be approved to receive Net-60 and extended terms
Works best for small business buyers