With a wealth of funding options available to small business owners, it’s no wonder that so many flounder when it’s time to actually go on the hunt for financing. It can be tough to come up against so many choices – and everybody will suddenly have an opinion on which type is the best for you once you’ve expressed your intent to secure funding.
It’s critical that you understand your options if you want to make the best choice possible for your business. With that in mind, here are seven ways to fund your small business along with a little head start on the need-to-know highlights for each method.
Small Business Administration 7(a) loans (or SBA loans) are widely lauded as an ideal way to fund a small business. Because they’re guaranteed by the SBA, which is a federal agency, you’ll often find lenders offering these loans with lower interest rates and more flexible terms than other financing options.
One key benefit to an SBA loan is the generous length of time you’ll have to pay back your loan. Loan terms depend on how you intend to use the funds, but are clear and easy to understand. If you use the money for working capital or daily operations, you’ll have seven years to pay it back; if you opt to spend it on new equipment purchases, you’ll get ten years before your final payment is due; and if you’re making real estate purchases, count on up to 25 years before payments should be completed.
For some borrowers, however, the process of getting approved for a loan from the SBA can prove difficult. If your business is struggling, you’ll likely have a harder time securing an SBA loan. The process is also more time-consuming than some other funding options, but can be worth the extra steps for the low cost of funds.
- Low interest rates
- Alternative SBA-backed loans available such as Microloans and Patriot Express Loans for military members & veterans
- Ample time to repay
- May be tough to acquire
- The program’s maximum loan amount is $5 million
- Requires business owners to have their own money invested
Traditional Bank Loan
When you consider getting a small business loan, your first thought is likely to go to the bank to get financing. If you do elect to follow that route, you’ll find yourself with a traditional bank loan. These loans tend to be some of the lowest-cost funding options available for small businesses. They offer predictable and clear monthly payments and are a great way to fund your operations.
The greatest downside to a traditional bank loan lies in the requirements. Unlike many other financing options, bank loans come with stringent requirements. You’ll need exceptional personal and business credit scores, substantial collateral, a couple of years in business, and proof of healthy finances – things you may be without if you’re on the hunt for financing.
- Low cost with reasonable interest rates
- Predictable and stable monthly payments
- Longer repayment terms offered
- Takes considerable time for approval and funding
- Need to have valuable and ample collateral, excellent credit and remain profitable
- Many businesses won’t qualify
Line of Credit
When a traditional business loan doesn’t offer enough flexibility, looking at a business line of credit can be a great option. Whereas traditional term loans offer a lump sum of cash that needs to be repaid over a certain timeframe, a line of credit allows you to reuse and repay money as often as you need (similar to how a credit card is used). This is, of course, provided that you don’t exceed monetary limits and you make your payments on time.
The process of applying for a line of credit is relatively similar to a bank loan, depending on the type of lender you select. You’ll need to provide a lender with standard documentation like personal and business tax returns, financials and banking info. Ideally, your personal credit score will be over 500– but some online lenders are more lax with requirements like this.
- Reuse and repay money as needed
- Lower rates than credit cards
- Only charged interest on the amount outstanding
- Typically have shorter terms than traditional loans
- Borrowing amounts can be limited
- Generally need some business history and strong revenue
Merchant cash advances (or MCAs) are typically given out with lenders’ insistence that they are not loans; rather, a provider will offer an upfront sum of cash and you’ll be responsible for paying the provider back with a portion of your future sales.
A provider will transfer the funds to you upon approval. This sum is given to you with the understanding that you’ll repay them using a slice of your future debit or credit card sales, which is also how the funded amount will be determined.
You may have also heard of a similar type of funding that is repaid by the provider taking daily or weekly debits from your bank account – these are now referred to as an ACH loan (see next section).
- Quick approval with minimal paperwork required
- If your repayment schedule is based on sales, you may be able to make smaller payments when business is slow
- APRs tend to be exceptionally high
- No benefit when you repay early
Automated clearing house (or ACH) loans are some of the most innovative funding solutions available to business owners. When you apply for this type of loan, a prospective lender will go through your business’ bank statements to determine a few basic, need-to-know factors. The amount of your loan, its duration, the interest rate, and other factors will be determined on an individual basis centered around your need’s and the provider’s comfort level.
Repayments for ACH loans are withdrawn automatically on prescribed dates from your company’s bank account. These payments may be daily, weekly, or even monthly depending on the provider and their risk assessment. This funding option is becoming widely popular mainly because approval and funding are so quick with minimal documentation required.
- Quick process
- No collateral
- Low credit is not an issue
- Overdrawing becomes easier
- Short-term solution with high interest
- Easy to forget what you’re paying and lose track of funds without physical bills
Invoice factoring is a type of funding where you agree to sell your invoices to a factoring company at a discounted rate in order to receive cash upfront (before your customer’s payment is due). Following this agreement, your outstanding invoices are immediately turned into cash and now belong to the factoring company, who will then get paid when they collect payments from your customers.
Some factoring companies are bank-owned, but most are private which means that each has their own set of internal requirements. Overall, most factors will only work with companies who have B2B invoices and are paid after the product or service is completed. To learn more about Evergreen Funding’s requirements and to see if your business qualifies, click here.
One key benefit to factoring is that it allows a business to hold onto loyal customers. Even if you personally can’t wait through long payment terms to receive funds, there’s no need to lose customers over it – handing your invoices over to a factoring company allows your customers ample time to pay without losing out on cash flow or even worse – the potential loss of that customer altogether.
Maybe more importantly, you have access to funds when you need them with minimal limitations. With a loan or line of credit, you have to request an increase from the lender which usually involves a full review of your account, new financial statements, and ample collateral to support the amount requested. With a factoring company, as long as your customers have the credit to support the bump in revenue, your funding is typically approved immediately. This means if your sales increase next month, you can count on the funding to increase as well which is a huge benefit to most companies.
- Can provide cash immediately
- Easy to increase funding amount
- Less stringent approval requirements
- No scheduled repayments to worry about
- Can be loss of direct control over invoices
- No guarantee that the invoice factoring company will collect on invoices
- Costs more than traditional bank funding
- Your approval relies heavily on the credit strength of your customers and their ability to pay
Purchase Order Funding
Purchase order funding provides your business with a cash advance intended to pay suppliers in order to fulfill customer orders, and is used in conjunction with factoring. Purchase orders are sold to a P.O. financing company in exchange for immediate cash to keep general fulfillment running as usual.
In order to qualify for purchase order funding, you’ll need to meet a few key requirements. You have to sell finished goods to B2B companies and your profit margins must be at least 15%. A decision to work with you will be based heavily on the creditworthiness of your customers and suppliers. It’s an ideal solution for distributors, wholesalers, and resellers.
- You pass on collections risk
- Ready access to cash to fund upcoming orders
- Often cheaper than relying on credit to make ends meet
- Can negotiate better terms with your suppliers
- You don’t receive total cash value
- Customers no longer deal with you directly
- Payment is taken upfront
- Requires healthy gross profit margins upwards of 15-20%
If you’re interested in learning more about how to fund your small business through options like factoring and purchase order funding, contact our team today. Our expert staff will be glad to assist you in finding the right option (or combination of options) to meet your business and funding needs. Together, we’ll work to elevate your business to the next level and get you the funds you need to make your goals a reality.