When you run a startup, finding funding is one of the most pressing challenges you will encounter. Since many lenders require borrowers to have a healthy financial track record, it can be a struggle for new businesses with little history to obtain financing. However, there are a number of financing options available to startups.
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What is a startup business loan?
Startup business loans generally refer to loans that are tailored to young businesses—typically those that have been in business for under a year. While many business founders rely on their own savings and assistance from family and friends, it’s common to need additional capital to help your business grow, and many lenders offer products specifically for new businesses.
Loans from traditional banks may have strict requirements that make them difficult for startups to access. Although many lenders require businesses to have been operational for at least a few years before qualifying, there are a number of loan types and funding sources that are suitable for new startups, including SBA loans, microloans, and more.
How do startup loans work?
There are many types of loans for startups, and their requirements vary widely. In general, you will need to have a good idea of how much money you will need and a strong plan for how you will use it. Your business plan is the most important part of your loan application as a startup, as the lender will want to see that you’re prepared to succeed. Lenders will also likely consider your personal credit score and financial information, business bank account statements, and business credit score if you have one. Some loans may also require collateral.
The amount of time you’ve been operating your business has a big effect on your loan options, with more options becoming available the longer you’ve been in business. You are more likely to be able to receive loans from online lenders, microloan lenders, and other sources after you’ve been in business for at least six months.
Loans can be used for a variety of purposes, including purchasing equipment, supplies, furniture, inventory, or real estate, as well as general working capital. Some loans may have restrictions on how they can be used, while others are open to most business purposes.
What types of startup business loans are there?
Startup businesses have a variety of options when it comes to funding. Below, we review a few of the most common financing products for startups.
You can receive a number of loan options through the U.S. Small Business Administration. With programs such as the 7(a) loan program and the 504 loan program, the SBA does not directly lend funds but partners with lenders to guarantee up to 85 percent of the loan, taking on some of the lender’s risk. Requirements for these loans vary depending on the individual lender, but in some cases, startups may be eligible, especially if the founders have previous experience in the industry in which they plan to operate their business.
New startups are most likely to qualify for the SBA microloan, which offers loans of up to $50,000, although the average microloan amount is around $13,000. Unlike the SBA’s other loans, microloans disburse funds directly from the SBA through local nonprofit lenders. Lenders have their own individual requirements for microloans, but it’s common for a personal guarantee or collateral to be required. Funds can be used for most business purposes but cannot be used to purchase real estate or refinance existing loans.
The SBA also provides resources and assistance to business owners, helping them create a business plan and complete loan applications.
The SBA is one of the largest providers of microloans, but other organizations offer these loans as well. Microloans are generally defined as short-term loans of less than $50,000. It’s a good idea to look for lenders in your area, as microloans are often provided by local or regional organizations. Nonprofits such as Kiva and Accion Opportunity also offer microloans.
Microloans are generally flexible and can be used for a variety of business purposes. In addition, they can help you build business credit, which will make it easier to obtain other additional funding later on.
When you apply for a microloan, lenders typically consider your business and personal credit scores, revenue, length of time in business, and the amount of funding you are seeking. As a new startup with less established finances, you will need to have a strong plan for how you will use the funds and a good business plan to qualify for a microloan.
Purchasing equipment can be a major portion of the costs of starting a business. Equipment financing allows your business to purchase equipment and pay it off in installments over time, similar to a car loan. Equipment financing is generally easier to get than other types of loans since the equipment itself can act as collateral, reducing the risk for the lender. Banks, credit unions, and online lenders may offer equipment financing.
Equipment financing typically has favorable terms, with fixed interest rates that are usually fairly low, and longer loan terms that keep payments manageable. You may be required to pay a down payment of 10 to 25 percent of the equipment’s cost.
If your business sells products or services, you may allow customers to buy on credit. This is especially common for business-to-business companies. When your company is new, waiting for invoices to be paid can have a major impact on your cash flow.
Invoice financing can help companies cope with this problem by allowing them to borrow money against their unpaid invoices, with the invoices themselves serving as collateral. For new companies that deal with invoices, this can be a helpful way to get through tight spots. Invoice financing is usually relatively easy to qualify for compared to other loans.
Business credit cards are a common and useful source of funds that most businesses will take advantage of. If you’ve been in business for six months or less, you can still qualify for a business credit card, and the application process is typically simple, only requiring your federal tax ID or social security number. No collateral is generally required. You can borrow as much or as little as you need, up to your credit limit.
Many business credit cards offer a period of zero percent introductory APR, which functions like a free loan, allowing you to carry a balance without accruing interest. You can make use of this as you launch your business, but it’s critical that you pay off your debts before this period ends to avoid paying interest, as business credit cards have high interest rates compared to loans.
A personal business loan is a loan taken out by an individual for business purposes. This type of loan can be a good option for new businesses without a long operating history, as personal business loans are approved based on your personal financial history, rather than your business’s financial qualifications, and they do not require collateral. This makes them easier to qualify for, especially if you have a good personal credit score.
Personal business loans have less expensive interest rates compared to short-term business loans, and they generally offer small loan amounts, which could be ideal for getting a new business off the ground.
The danger of a personal business loan is that your personal assets and credit history would be at risk if you are unable to repay the loan. In addition, mixing your personal and business finances can create legal and bookkeeping challenges, so it’s important to be careful with your records.
Other Funding Options
In addition to loans, you may want to consider these additional funding options:
Grants for Small Businesses
Grants for small businesses are available from governmental organizations, nonprofits, and corporations. Many grants focus on businesses that work in technology, science, or environmental industries, businesses that benefit local communities, and businesses owned by underrepresented people.
Grants typically have specific eligibility requirements, and applications can be competitive and time-consuming. You will likely need to have a strong business plan and may be required to prepare a presentation or statement for your application. In some cases, grants will require businesses to be fully operational before you apply. However, startups are eligible for some grants, and the money they provide can be incredibly helpful, so it’s a wise idea to search through available grants to see if your business qualifies.
Some sources of government grants include:
- America’s Seed Fund
- Small Business Innovation Research (SBIR) and Small Business Technology Transfer (STTR) programs
Crowdfunding enables many people to collectively fund a project that interests them. Crowdfunding websites such as Kickstarter, Indiegogo, and Fundable allow members of the public to pledge money for projects they care about, often in exchange for special benefits. Most successful crowdfunding projects offer a specific end product, such as a technological gadget, game, or toy, or take advantage of an existing fanbase.
Many companies have had success with crowdfunding, but this method of funding has its drawbacks, so it’s important to make sure that you understand crowdfunding before launching a campaign. When you start a crowdfunding campaign, it’s crucial to make sure that you set a realistic funding goal, as many crowdfunding websites only allow you to keep the money if the project achieves its goal. In addition, it’s common for the scope of a project to increase over time, so ensure that your goal can be reached with the planned amount of money.
Because offering rewards for backers is a big part of how crowdfunders make their campaigns appealing to pledgers, it’s easy for companies to promise big, exciting rewards and struggle to deliver them when the time comes. Be sure to offer rewards that you will be able to deliver.
There are a variety of loan options and lenders in the market, and it may be difficult sorting through all of the options. AdvisorSmith analyzed over 30 different lenders and determined the top lenders for small businesses. To determine the best lenders, AdvisorSmith considered a number of factors, including financial strength ratings, customer satisfaction data, complaint ratings from the Better Business Bureau, available terms and loan amounts, and availability of information and ease of use of the lender websites.
|National Business Capital||Overall||National Business Capital is a financing marketplace that specializes in connecting small businesses with a variety of loan products and over 75 lenders.|
|Rapid Finance||Short-term Loans||Rapid Finance is an alternative lender known for offering a variety of short-term loans targeted at small and midsize businesses.|
|Lendio||Startups||Lendio is a financing marketplace that works with a variety of lenders, many of whom offer loans specifically for startups.|
|Fundbox||Lower Credit Scores||Fundbox is an alternative lender that is best known for offering lines of credit and invoice financing for small businesses.|
|Accion Opportunity Fund||Microloans||The Accion Opportunity Fund is a non-profit lender focused on providing funding to small businesses, particularly business owners who are underrepresented minorities and women who may not qualify with other traditional lenders.|
Finding funding for your new startup can be difficult, but there are a variety of ways to obtain the financing that will help your company get up and running. From microloans and grants to business credit cards and equipment financing, you will need to evaluate your options carefully, and many businesses combine several resources to gather the necessary cash. With wise financing choices, you can set your company up for success.
AdvisorSmith spoke with the following experts to provide critical insight on funding for startup business owners.
- Associate Dean & Associate Professor of Management
- Loyola University Maryland, Sellinger School of Business
- Assistant Vice Provost for Entrepreneurship
- Executive Director of Entrepreneurship Clinic
- North Carolina State University
- Assistant Professor of Entrepreneurship
- Northern Illinois University, College of Business
- Clinical Associate Professor
- University of Massachusetts Amherst, Isenberg School of Management
- Adjunct Lecturer
- York College, CUNY
Q. What are the best sources of financing for startup businesses?
Hung-bin: The best source of financing is a subjective decision. Entrepreneurs generally prefer low cost and patient financing solutions. Traditional bank loans are reasonably patient with reasonable costs. However, new products such as small angel funds, microfinancing, and even crowdfunding have great appeal to entrepreneurs and small business owners.
On top of these emerging solutions, family, friends, and bootstrapping remain strong competitors to banks. The traditional bank loans are still attractive to many people, but the best source of financing is one that best meets the needs of an entrepreneur.
Lewis: It depends. When launching and funding a startup, the founder needs to determine if they are building a scalable or lifestyle venture. Sources of funding can be the founder’s savings, family & friends, crowdfunding, grants, competitions & accelerators, banks, private (angel) investors, and/or venture capital. However, each has different expectations of a return on their investment. If you are building a lifestyle business, it is unlikely your will reach the revenue needed to provide an expected multiple, sometimes as much 10 times, of the investment from venture capital.
Tim: There are many ways to finance a new business. One of the best ways is by using your customers’ cash up front or through re-invested revenue. There is a great book that details these methods and business models, titled, The Customer Funded Business by John Mullins.
Other alternatives for funding aside from traditional bank loans are via personal savings accounts, asking family and friends, debt-based or rewards-based crowdfunding, government grants like the SBIR program, pitch competitions for nominal funding, joining an accelerator to get access to local area angel networks or angel funds, and, for more established companies (with growing revenue), venture capital or private equity firms. Databases like Pitchbook, Crunchbase, and PrivCo can provide some contact information for these groups stratified by location.
Charles: Early stage companies will try to bootstrap as much as they can, using their own personal resources. Maybe they start their business as a consulting business, where they are getting some cash flow from customers for consulting gigs, and while they are consulting, they are developing their prototypes and developing skills and turning that into useful technology.
There’s all kinds of things that people can do to bootstrap their business, like getting customers to pay up front and getting customers to help finance your business. If you can get your customers to help finance your business with the promise that you’ll use them on a long-term basis, now you’re beginning to talk about ways that companies really are able to effectively finance their companies.
If I’m starting a more traditional Main Street business, like a clothing store or restaurant, I’m probably going to need to have some startup money that I get from friends or family. Many localities also have business development grants or loans available for small businesses, and there’s also SBA-backed loans through your local bank. SBA loans generally take around four or five months to get, whereas credit cards, which is another alternative, can allow you to borrow instantly.
Joseph: The best source of financing for a startup is equity financing. Equity financing simply means raising money that you do not have to pay back in exchange for giving up some percentage of your ownership in the business to the entity or individual who gave you the money. Equity financing also means using your own money. That is, besides loans from traditional commercial banks and the small business administration, you can finance your startup that does not involve borrowing money you have to pay back. These sources include:
- Venture Capitalists: These are companies whose primary purpose is to invest in the early stages of business startup in exchange for an ownership percentage in the company. They take on the risk hoping that the business will succeed one day and then cash in. Because of the risk they take, they usually want a high percentage of ownership so that they can have a say in the company. The good thing about venture capitalists is that they give you cash, and collateral is not required. Instead, you need to provide a good business plan, evidence of your experience in the industry, and that the business has the potential to succeed.
- Angel Investors: These are usually a group of wealthy individuals interested in investing in the start-up stage of a small business that they believe has the potential to become profitable in exchange for an ownership percentage in the company. These are individual private investors, primarily former business owners who have sold out their businesses and retired but decided to invest in startups for higher returns instead of leaving their money in the bank or the stock market. They are generally flexible and will invest in your startup if it has the potential to grow, and they like your idea. They can be very helpful in imparting knowledge, being experienced as previous business owners. There are various angel investors’ clubs around the country.
- Crowdfunding: This is simply the process of collecting small amounts of money from a large number of people through social media and a crowdfunding website to finance your business. There are, however, some restrictions on who can fund a small business venture and how much they can contribute because of the potential to abuse the process.
The primary alternative source of debt financing is the SBA. The Small Business Administration offers various financing programs to help small businesses acquire fixed assets, such as land and building, expand an existing business, and pay for day-to-day business operations. Note that the SBA by itself doesn’t lend money directly to businesses; instead, it acts as a guarantor to the bank on behalf of the small business owner. Meaning, the SBA will repay some or the entire loan if the small business owner defaults. This guarantee from the SBA makes it more likely for the small business owner to receive financing from the banks and other institutions that partner with SBA.
Below are six SBA loan programs that a small owner may qualify for:
- SBA 504 Loan Program – up to $10m
- SBA 7(a) Loan Program – up to $5m
- SBA CAPLines – up to $5m
- SBA Microloans (SB)
- SBA Surety bonds
- SBA Small Business Investment Companies (SBIC)
Another alternative source of funding is peer-to-peer (P2P) lending. Also known as social lending, P2P lending is the process of connecting lenders and borrowers directly on the internet without financial institutions as middlemen. There are many online services (P2P platforms) that connect people who want to lend money and those who wish to borrow. The process is pretty straightforward; with the help of the P2P platform, borrowers complete and post an application form stating the amount of money they are looking for, and lenders post the term and conditions of their offer. It is up to the borrower to accept an offer or various offers from different lenders. It can be the fastest way to borrow money and finance your small business. Websites such as Lending Club, Prosper, Peerform, Upstart, and StreetShares are among the facilitators of P2P lending.
Q. How can startup businesses increase their chances for getting approval on a loan?
Hung-bin: Anyone can seek asset-based loans. However, for entrepreneurs who do not own meaningful assets, getting credit lines from lenders is still possible. Credit lines, however, are most likely given to businesses with good track records of operation. Keeping a good credit record and having the business up and running even at a small scale will be really helpful.
Lewis: For a bank loan, the return on investment to the bank is the interest it receives from the borrower. To mitigate their risks, they rely on collateral to secure the loan and increase the opportunity for a return. For a founder borrowing money from a bank, their collateral could be tangible assets, like equipment or inventory, or intangible assets like your personal guarantee (your credit score). To increase your chances for a loan, show your projections of being able to repay the loan at the terms expected and that you have collateral to protect the bank against failure of the startup.
Tim: One thing that many people should do is to sign up for a business credit card earlier in life to establish a business credit profile. This is important because personal and business credit are two different profile or reports on an individual’s creditworthiness.
Nobody needs to launch a large company to get a business credit card. Oftentimes, people don’t realize they already have a side hustle that qualifies as a business, e.g., selling on eBay or Amazon, pet sitting, baking, crocheting animals, handyman projects, landscaping, consulting, or moonlighting from your traditional job, and really anything where you provide a product or service to someone in exchange for money. Having established credit before starting your dream company can help get you approved for larger credit lines with banks.
Charles: Having a good personal credit score is critical. A lender is also going to look at your business idea and plan. Having industry experience and a track record will also be compelling to lenders. Lenders will not only look at the economics of the business, but also the quality and experience of the management team.
Joseph: Startup businesses need to have a business plan or strategy that clearly defines who their customers are, their needs, and how to satisfy those needs. They need to articulate how their product or service is unique or better than anyone else’s in terms of taste, quality, design, or experience. Even though those who finance startups have a checklist of things they want to see in a business plan, they rely on what might be called pattern recognition. That is, because of their experience, they have an idea of which business will make it or not based on the patterns they have seen in startups.
Q. Do you have any tips for startups looking to receive first-time business loans?
Hung-bin: Stretch the money and get the business running first. All sources of loans want borrowers to succeed. The successes of borrowers create a positive feedback loop for lenders, borrowers, and even the community.
The actions of making and selling products/services enable entrepreneurs to interact with the target audience and to gain valuable market intelligence for their businesses. An entrepreneur can increase the odds of success by actively learning from the market. Loans favor promising businesses.
Lewis: Build a relationship with the bank. As time passes, you potentially can reduce the risk to the bank and make them more susceptible to lend your startup money to grow your business.
Tim: Those who are starting a company need to develop a clear value proposition that details the market demand and price for their business’s products or services over the next 24 months. Providing a sales forecast in simple terms is step one.
Next, highlighting market demand and explaining why you and your team are uniquely able to deliver your solution to customers is something that all investors require before funding your business. All seasoned entrepreneurs understand that people invest in people, so it is critical that you can articulate why you are motivated to make your business successful, the strategic partners who are willing to help you, and gathering statements from different stakeholders (e.g., vendors, customers, etc.) on their willingness to help you or buy your business’s products will go a long way in improving the odds of receiving funding.
It is important to recognize that receiving funding takes time, typically at least six months of talking with an investor before they are willing to provide funding. It is a lot of work to develop and manage a social network for one’s business, which is why the most common way for all startups is to self-fund their business.
I recommend startups have very concise one-page statements for each aspect of their business model completed and saved via a cloud database (e.g., Dropbox, Google Docs, etc.) because you never know when you will find the right investor, so having well-articulated plans at a moment’s notice will help if the goal is funding aside from traditional options like bank loans.
Charles: Make sure that you really understand the cost of the loan. So for instance, there are some small loans that you can acquire from online lenders, where you pay back the lender by the lender taking a percentage of your cash receipts. And often those interest rates are calculated at a very, very high rate. You could wind up having a 35% interest rate on one of those loans, so you need to have a good understanding of what the APR cost is.
Another thing that I would do is ask a potential lender for the names of other businesses that they’ve lent money to in the last several months, and ask if you can have an opportunity to talk to those people and check references. Checking references on lenders is something that oftentimes entrepreneurs are afraid to ask, but it’s a really smart thing to do.
Joseph: When presenting your ideas, be enthusiastic and passionate about your business idea, know your industry, and get the facts right about your industry.