Any number of factors can make or break a new business. Financing, or lack of it, tends to be among the most important. Start-up funding also is one of the most difficult tasks for inexperienced new business owners. FindLaw's Start a Business section provides information on working capital and every funding option.
Generally speaking, there are two types of financing: debt financing and equity financing. Debt financing is a loan, line of credit, or promissory note. Equity financing is a financial investment in exchange for a share of ownership in the business. (Of course, a business can also begin with a gift.)
A prospective business owner will need to decide two things upfront:
- What type of financing do you want?
- What cash flow and financing is available, and affordable?
- How much financing do you need?
Some types of financing and sources of financing may be easier or harder for your new business to access. Investigate each financing and loan option and target the most likely sources for your business funding.
Sources of Start-Up Financing
There are at least a dozen sources of small business financing discussed in this section including:
- Self-financing
- Gifts and donations
- Loans from family and friends
- Small business grants
- Small business loans: Crowdfunding and microlending, U.S. Small Business Administration loans, government loans, and financial institution loans
- business lines of credit
- Equity investors
- Venture capitalists
Self-Financing
Many entrepreneurs start a business with no money and begin by self-financing. They may purchase their own supplies from savings. They may use personal credit cards or take out a line of credit against their home mortgage. They may borrow from a life insurance policy.
Before you get in too deep, take some time to think about personal finances vs. business finances. Yes, you want a successful business startup, but how can you insulate your personal credit score and personal credit history from the risks that come with owning a new business?
Gifts and Donations
There are 1.8 million nonprofit companies in the U.S. Often they start with no money and a lot of hard work from dedicated volunteers with a vision. But if the nonprofit wants to grow and become even more effective in meeting its mission, how will the nonprofit make money? Through donations and gifts.
There are a number of state laws and tax rules that apply only to nonprofits. You can find information at your Secretary of State's office. Your state may also have a nonprofit that operates specifically to help other nonprofits become more successful.
Can a for-profit business receive a gift? Yes! Friends and family may want to give a gift of money or equipment to a new entrepreneur. That gift won't be tax-deductible if the business is a for-profit, but that's not always important for family members. If the value of the gift exceeds the gift tax exclusion limit for the year, the gift giver will have to pay gift tax on the excess.
Loans from Friends and Family
It's more common for a start-up business owner to get money from family and friends in the form of a personal loan or business loan. Good credit? Bad credit? That's not usually as important with family members if you can show them a good business plan. Collateral is usually not required and the interest rates may be better than a typical bank loan.
Treat a loan from friends and family as you would any other business loan. Provide your personal lender with a business plan. Write down the terms of the agreement. Create a schedule for monthly payments. A family or friend may be flexible with the date loan repayment begins.
Small Business Grants
Depending on the type of business you are starting and your location, you may be able to find small business grants. You will still need to have a solid business plan and you will need to do the paperwork required to apply. If you get the grant, you won't have to repay it. Business grants are offered through federal, state, and local government agencies. You can often learn about available grants through a local chamber of commerce, or a business association.
Small Business Loans
There are several ways to get small business loans, depending on the amount of money you want and the terms you are looking for. Have your business plan complete and your financial paperwork in order so you are ready when an opportunity presents itself.
Microloans: Microloans are “small" loans that are specifically meant to help startup businesses and small businesses. The microloan program you apply to will have an upper limit, often between $5,000 and $50,000. A microloan will have repayment terms and interest will be charged.
The SBA microloan program assists lenders in making small, short-term, fixed interest rate loans to start-up businesses.
Crowdfunding is a way to raise money for projects or early-stage business startup. All crowdfunding sites raise money from a large group of people making usually modest investments. But crowdfunding sites operate differently.
- Some sites operate purely as donation-based crowdfunding. This may be a good way to get a nonprofit off the ground.
- On some sites, the business owner provides a reward to the donor. For example, in exchange for development funding, the donor will receive an early release of the product, or a special version of the product. Kickstarter businesses usually offer a variety of rewards to their microlenders.
- Some sites are peer-to-peer lending sites. The international microlending nonprofit, Kiva, crowdfunds short term loans for business owners and business collectives all across the globe, including in the U.S. When the requested loan amount is raised, the business owner receives a lump sum amount. If the project is not fully funded the borrower receives nothing. Online lenders are paid back their investment but any interest on the loan is paid to the originating agency in the country of origin. Other peer-to-peer lending sites operate differently and may include interest.
- The high end of crowdfunding is equity crowdfunding. Investors can overcome the accreditation requirements by pooling their investment dollars with others and gaining a small amount of equity in a business. An example of this kind of Crowdfunding is MnVest, a way for lower-level investors to invest in Minnesota businesses. Another example is the Angel Investors Network.
There are a lot of ways microlending can go wrong. Become familiar with the rules and plan carefully before you choose an online lending service.
Government Loan Programs: The Small Business Administration offers direct SBA loans, loan guarantees, and assistance to lenders. The USDA provides loan guarantees for businesses that save or create jobs in rural areas.
State Loan Programs: State financing varies greatly but al states encourage business development offer business financing from state investment fund appropriations and the federally funded Small Cities Development Program. Loans are not necessarily targeted to small businesses or start-up businesses but may be available to established businesses as well.
City/County/Municipal Financing: Local units of government may offer financing assistance in the form of business loans, tax credits, or tax increment financing.
Financial Institution Lenders
Commercial Bank Loans: Most banks provide business financing in the form of bank loans, business lines of credit, accounts receivable financing, and other options. You can always start with the bank where you have a personal bank account.
A personal guarantee of the owner or collateral may be required to back the loan, especially for small business startups without a track record or business owners with bad credit. Real estate or a home is common collateral for new small business owners.
Investment Banking Firms: Investment bankers can help companies go public by offering company stock (an ownership interest) to the public.
Community Development Financial Institutions: These mission-driven banks invest federal dollars alongside private sector dollars to promote economic growth in financially distressed communities. Qualifying for a start-up business loan in a low-income community may be easier at a CDFI bank.
See the resources in this section of the FindLaw Small Business website for Do's and Don'ts of applying for a bank loan and the financial documents you will need to gather in order to apply for a loan.
Credit
A note on credit cards: If you have a personal credit card, you have a built-in line of credit you can use for your business. But credit card fees are high. It's one of the costliest ways to finance your company. As soon as your business has a financial track record, look for a business credit card.
Another form of credit that may be available to a startup or growing business is trade credit offered by vendors and suppliers.
Equity Investors
For a significant investment, an equity investor buys a share of your small business. Because the equity investor is taking a bigger risk by making a large early investment, they often ask for a higher percentage of the company's profits. Before you decide to go this route, research the pros and cons of small business loans versus equity investment.
And look into equity Crowdfunding as an option. Equity Crowdfunding intermediaries include AngelList, Early Shares, and Crowdfunder.
Venture Capital
Very few small businesses are able to obtain financing through venture capital firms, but it's good to be aware of this financing option once your company has a track record of growth.
Financing Basics
Having a solid business plan and financial documents in place will be essential to securing startup financing. Take a look at the sample financial documents in this section: a balance sheet, startup costs, profit and loss statement, and a personal financial statement.
Hiring a Business Attorney
Whether you are starting a business as a sole proprietor, as a member of a partnership, or as a new corporation, a business law attorney can assist you at every step of the process, to help your business open its doors and succeed. No matter what type of business start-up issue you face, a business attorney can help you find the right solution for your new business such as choosing the right business structure for your needs.
