Types of Business Funding for Small Businesses
Finding the right financing can help entrepreneurs turn their aspirations into a profitable reality. There are plenty of business funding options to choose from, but the best fit for your type of business depends on various factors and whether debt financing or equity financing makes the most sense for your situation.
Debt Financing vs. Equity Financing
The difference between debt and equity financing is that one needs to be paid back, and the other does not. Debt financing refers to business loans or lines of credit, which you pay back over time with interest. Equity financing is when angel investors or venture capitalists provide funds in exchange for ownership shares in the company.
Below is an overview of the most common types of business funding for Oregon small business owners and the benefits and risks associated with each.
Also referred to as self-funding or bootstrapping, 58% of startups fund their business with personal assets. This is when you leverage your own financial resources, like your personal credit cards, your savings accounts, your 401(k), or drawing from your home equity.
The benefit of using personal assets is that you retain complete control of your business. Of course, you will also be personally liable for financial risk. Before you decide to fund your business from your own assets, it is best to speak with a financial adviser, as there could be tax penalties or fees involved if you’re withdrawing funds from your retirement account or other assets.
Funding from Friends and Family
Aside from using your personal assets, you might have family or friends willing to support your business entity with funding, either as a gift that does not need to be paid back or as a loan that will need to be repaid. But this type of loan will likely have lower interest than borrowing from a traditional bank.
Turning to family or friends for financing allows for quick and easy access to the funds. Additionally, it is not dependent on factors like your credit score or an extensive review of financial documentation. But it does carry a personal risk: If you don‘t pay back the loan in time or if the business fails, it could jeopardize your personal relationship.
Small Business Loans
Traditional bank loans
Traditional banks offer several types of financing for small businesses, including term loans, lines of credit, loans for business equipment, commercial real estate loans, and business credit cards.
Bank loans typically have low interest rates and competitive terms but come with stricter eligibility requirements for business financing. So these loans are best for established businesses with strong revenue. Bank lenders will examine your credit score, personal income, and more to ensure that you meet their lending standards.
You can apply for a small business loan with a large bank or a local bank in your community. It’s worth noting that, according to the Federal Reserve’s 2022 Small Business Credit Survey, applicants reported higher approval rates for business loans through smaller banks than the big-name banks.
For small businesses that don’t meet the lending criteria of traditional banks but still have a good credit score and have been in business for at least two years, an SBA loan could be another option.
SBA loans are business loans offered by the U.S. Small Business Administration to lenders such as banks, credit unions, and other financial institutions. These loans are backed by the federal government, so they are less risky for lenders. And, for borrowers, they come with favorable rates and lower fees than traditional bank loans.
Some types of SBA loans include SBA 7(a) loans, SBA 504 loans, and SBA microloans. You can find more details on each type and the lenders in your area that offer these loans on SBA’s website.
Venture capital is funding provided by angel investors or private equity firms that are focused on specific growth-industry sectors in exchange for an ownership share in the businesses they fund.
This differs from traditional financing, as venture capital is not a loan or a line of credit. Instead, it’s investing money in return for equity in the company. Therefore, business owners give up some ownership control.
Obtaining venture capital starts with finding potential investors and pitching your business plan. Then it involves an extensive review of your management team, market, products or services, business financials, and more. Before seeking venture capital, you might want to get an independent third-party valuation of your business. This step can help you attract potential investors.
Once venture capital is secured, the funds are usually dispersed in “rounds.” As the business meets certain milestones, more funding rounds become available. The benefits of this type of business financing are that it promotes a positive cash flow and business growth in planned stages without having to take on any debt.
Crowdfunding is another way to access funding. Platforms like Kickstarter, Fundable, and others can also help build brand awareness and test-market your business idea among investors and consumers.
There are four ways to do crowdfunding:
- Donation based: Donors give money for nothing in return.
- Equity based: Investors provide funds in return for shares in the business.
- Debt based: Investors are repaid with interest.
- Reward based: Those who donate receive products or services in return.
Crowdfunding does have the potential to raise funds, but you will be competing against thousands of other businesses. That means you’re not guaranteed to succeed. For starters, you will need to have a rock-solid pitch and will need to market your campaign effectively to make sure that potential investors see it. And if you’re doing reward-based crowdfunding, you’ll need to offer enticing perks to encourage donations.
How the Oregon SBDC Can Help You Access Business Funding
The Oregon Small Business Development Center (SBDC) Network’s Capital Access Team (CAT) assists small business owners in the state of Oregon with financing strategies through our specialized advising, training, and support services.
You can register for confidential business advising with your local SBDC. CAT advisers can help you explore the capital landscape, review funding packages, provide feedback, and coach you on how to pitch potential investors. We invite you to visit the Oregon SBDC CAT Capital Landscape page. There you will gain a deeper understanding of the different types of business funding options that might be available.
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