Funding Options for Small Businesses

A Quick Guide

It’s overwhelming for a small business owner to figure out how to get capital to start or grow his/her business. There seem to be so many options out there. But when you look into individual options, they are all fairly difficult to obtain. After spending numerous hours of research on this topic, here are some viable solutions I found, sorted by amount of effort.

Savings, Friends & Family, Home Equity & Credit Cards

The easiest way to get capital for your business is your savings. There’s no documentation required. If you don’t have a lot of savings, you can borrow against your home equity if you are a home owner, which typically costs about 4.5% with very little documentation. You can also borrow against your existing credit cards, rates ranging from 10% -30% depending on your FICO scores and you can often get 0% introductory APR for the first 12 months. I personally think credit cards is a pretty viable short term financing solution but if you have to rely on it for a long time, you might want to consider some other lower cost solutions.

If you have a good support network, you can also consider borrowing from your friends and family. In the current lending climate, it’s actually one of the best options if your business is less established. Personally, If I need funding, I will try borrowing from friends and family before I take a very expensive option like Merchant Cash Advance or a loan from Kabbage or OnDeck.

Online working capital lenders

There are a few emerging online lenders focusing on small business working capital, most notably Kabbage and OnDeck. The APR ranges from 25-60% with 6-month to 1 year term and you can borrow up to $50K. It is really expensive. But IT IS AN OPTION. If you can earn a high ROI from the borrowed the capital, i.e. purchasing inventory that would sell fast and with high margin, this would actually be a decent option. You can typically get funds within a week providing all the documentation has been submitted.

Requirements: some basic documentation to verify your identity such as copy of drivers’ license and EIN. You also need to link your bank accounts or other merchant accounts such as Paypal or Square to show your business generates steady cash flows. Most loans require personal guarantee.

MCA (Merchant Cash Advance)

If your business has credit/debit card sales, you can consider MCA providers such as AdvanceMe. Instead of charging an interest rate, you sell X% of your future card sales for $Y upfront with a total payment amount capped at $1.25Y or $1.5Y (the multiple varies). For technology companies with high profit margin that can prove revenue, there’s also Lighter Capital, which works in a similar way as MCA. There’s typically NO PERSONAL GUARANTEE REQUIRED for this option. It sounds pretty awesome, right? The only catch is that MCA is very very expensive and directly cuts into your margin for a period of time. APR typically ranges from 70% — 200%. It’s up to you to decide if the borrowing cost is worth it.

Requirements: MCA providers typically link to your merchant account and deduct a portion of your sales automatically on a daily basis. Based on this approach, their underwriting process is very different from other lenders. They would look at your card sales, verify your business and maybe look at your credit scores. In general, it requires a lot less documentation to get access. You would usually need to have 1+ years of operating history for your business to show enough data for your card sales.

Fixed Term Loans Done Online

In recent years, there’s been a slew of new generation online lending companies who offer competitive interest rates without requiring you to make a trip to your local bank branch. Most notable direct lenders include FundingCircle, DealStruck, Fundation and LendingClub. In addition, Biz2Credit is an aggregator representing a number of lenders online and offers many different financing options on behalf of the lenders. The APR in this category ranges from 6-25% with 1-4 year terms and you can borrow up to $500K. It’s a viable option if your business is more established.

Requirements: Identity verification for you and your businesses. You typically need to be in business for 2+ years. You also need to submit business plans, business and personal tax returns, financial projections for your business and more. Think of it as a bank loan that’s ported online. It would take some time to come up with all the documentation but if you already have it, it would be a breeze compared to talking to a bank. Most loans require a personal guarantee.

Online Asset Backed Credit Lines

Companies like FastPay or DealStruck let you borrow against equipmen or account receivables, typically up to 65% of the asset value. The interest rate is lower (6-15%) since it’s asset backed. It’s typically a revolving credit so it offers incredible flexibility for your ongoing financing needs and helps business owners manage their cash flows better. This is a great option for working capital.

Requirements: Requirements vary. At the minimum, it will require the proof of ownership and valuation of assets. It will also ask for personal and business financial information. The amount of paper work required correlates with the risk of the underlying assets, i.e. A/R for a government contract vs. A/R for a pre-funding tech startup.

CDFI lenders

You should check out the local small business development centers (SBDC) in your area to see if they can help you find good financing partners. A number of community development financing institutions (CDFIs) offer low interest rate small business loans as well as development assistance. It’s a great resource. The CDFI’s are subsidized by governments and foundations through grants and can get cheap capital from banks trying to obtain credits for the Community Reinvestment Act (CRA). Opportunity Fund in California is a great example. Borrowers typically get really friendly terms with low interest rates, i.e. 8-15% APR with terms up to 3 years.

Requirements: Similar to online installment loan lenders with A LOT of documentation requirements. Usually, you would talk to a field loan officer to complete the application process. This can take a lot of time and you may not get approved in the end even if you are qualified because there’s a limited amount of funding available.

Kiva Zip

In the past couple of years, Kiva Zip has taken the small business loans in storm. They offer 0% interest rate loans for entrepreneurs who are not *bankable*. It’s a KickStarter style of funding. Namely, the fund is crowd sourced from philanthropic minded lenders on Kiva. You can get a $5000-$10,000 first loan through the platform after you find a trustee to endorse you. Once you finish repaying the first loan, you can get bigger amounts. It’s a great option if you are just starting out.

This sounds like a really awesome option, doesn’t it? I completely agree. The only catch is it takes a lot of time to run a fund raising campaign and the amount raised might not be worthwhile for a lot of entrepreneurs.

Requirements: Sign up and talk to a Kiva Zip trustee, who will walk you through the process, understand your personal and business financial situation and decide if they want to approve you on the platform. Once you are approved, you need to give more information about your personal/business story and engage with the Kiva lenders to get the funds. The fund raising itself can take up to 6 weeks so there’s a lot of time investment involved.

Banks

Finally, you can talk to a bank about getting a loan. But most banks don’t like doing small business loans because of high overhead costs with low profit margins. If you want to borrow <$250K or have annual revenue less than $1M, banks would be a very difficult option. If you really want to talk to a bank, I would recommend you talk to a community bank or banks that specialize in small businesses such as CapitalOne or Wells Fargo.

With that said, I want to give you a heads-up on the various government subsidized programs. Small Business Administration (SBA) has offered a lot of SMB friendly programs through banks such as SBA 7(a) which offers $100K+ loans to small businesses including startups. There are also various SBA programs for working capital through credit lines. These are financial products partially guaranteed by the US government so the cost is lower but the amount of paperwork required is staggering and the process takes a long time. SBA 7(a), however slow and bureaucratic it is, continues to be the best ( and often times, the only,) financing option for new startups.

In addition, the SBA micro loans program is also low interest and doesn’t require a long business operating history. SmartBiz SBA Loans is a good place to learn more and apply.

Requirements: A lot of paperwork. Namely, whatever is required for online installment loan lenders plus a lot more. You need to talk to a loan officer to get more details as each bank requiresdifferent things too.

Bonus:

In addition to loans, there are other financing options from the digital age.

Equity Crowd Funding

Instead of borrowing money from investors or banks, you can give a slice of your company to investors in exchange for capital. It’s a very standard practice for tech startups, and companies like AngelList, MicroVentures, FundersClub and WeFunder have had a history of facilitating the equity investment for tech startups, hoping one of the companies becomes the next Facebook or WhatsApp.

If your company is not a tech startup, there’re more options popping up in recent years. CircleUp helps facilitate equity investments for burgeoning CPG companies. CrowdFunder is another platform that focuses on local small businesses. There’s also Bolstr, which employs a revenue share model for the companies they’ve curated. Equity Crowd Funding is not very mature for typical small businesses yet but its development is interesting and small businesses should pay attention to what’s coming up for the next couple of years. Once the JOBS act is fully implemented, hopefully these options would become more accessible.Requirement: You typically don’t need to submit a lot of personal financial information. But you will need to come up with an investor presentation in addition to the typical business plan and financial projections for loan applications. Imagine you are on Shark Tank and you want Mark Cuban to invest in your business. That’s what it takes.

Reward based Crowd Funding

Platforms like KickStarter and IndieGoGo help people raise money for a project or for a cause. You can leverage these platforms to raise money for your business by offering a (future) product or a token reward such as a “Thank You” card, a T-shirt or a handmade candle. If you are not raising a huge amount of money (ie <$5000), this can be a viable option with few strings attached.

Requirements: You have to be very good at marketing and present your product/business in a way that resonates with people. Once you put up your campaign, send it to your friends, family, community and customers for support. The campaign typically take weeks to complete and many campaigns do not get funded, so it’s not a sure bet.

Closing Remarks

Getting capital for a small business is a daunting task and takes a lot of time and effort. We all wish for a low-cost and low-friction SMB loan product but due to the high failure rate for SMB, this idealized product DOES NOT EXIST. Prioritizing what’s important for your business becomes the key to selecting your funding options and hopefully this long article serves as a quick guide to help you understand all the different options available today.