According to the US Small Business Administration (SBA), a “small business” is a company that hires fewer than 250 employees and has no more than $750,000 in annual earnings.
With these lower levels of revenue, a small business owner might think there aren’t small business financing options available for them. We’re here to dispel that myth.
If you’re thinking of starting your own business and looking for some help, read on for some tips on small business financing. If you do some homework today, you’ll find the option that’s right for you to bring your company to life.
Small Business Financing Options
There are many types of small business financing options on the market today. These tools can range from public (government) to private loans. Here’s a closer look at both.
1. Private Bank Loans
Private loans are usually executed with a bank, credit union, or other lending institution. Private loans are commonly used for financing equipment, buildings, or product development. They are repaid by a specified date.
Here are some examples of private bank loans commonly used today:
- Business Line of Credit – With this small business funding tool, a bank will agree to finance a specific amount on the condition that the small business owner agrees to pay back the balance before their next billing cycle starts.
If the borrower can’t pay back the amount, they’ll owe a service fee and interest on the outstanding balance. This form of small business financing is an optimal way for a company to build its good business credit.
- Equipment Loans – Some banks offer an equipment loan program to help companies purchase the equipment they’re going to need to manufacture or deliver their products. An equipment loan is secured against the equipment that’s eventually purchased.
Lenders can repossess equipment if a borrower doesn’t pay back their loan. Both borrowers and lenders will execute a loan contract that spells this rule out as well as lists what equipment to buy.
2. Public (Government) Loans
A government-backed loan doesn’t directly lend money to a small company. Instead, they develop policies for a micro-lender to negotiate with the borrower. The government will insure these loans, which can reduce risks to lenders.
Small Business Administration (SBA) loans are the most popular government-guaranteed loan in the market today. The SBA is a federal agency that cooperates with a pre-approved lender to offer funding opportunities to smaller enterprises.
There are several types of small business loans that a small company can apply for to expand its business. Some of these SBA loans include the following:
- 7(a) Loan Program – One way to fund business start-up expenses is the 7(a) loan program. Examples of these start-up expenses include buying uniforms or delivery vehicles. 7(a) loans can be as high as $2 million per small business borrower. The SBA will guarantee a 7(a) loan for about 75 percent of the amount or no more than $1.5 million.
- Microloan Program – A microloan program provides customized financing options that allow small business owners to borrow a small, or “micro-level”, amount to cover their day-to-day business expenses. The maximum amount that individual small companies can apply for is $350,999.
A non-profit organization can apply for a microloan. A food bank, for example, can apply for a microloan to help them with their start-up expenses. Microloan amounts are usually around $13,000 per borrower.
- CDC/504 Loan Program – Certified Development Company (CDC) or 504 loans are long-term loans that help small businesses contribute to their community’s economic development. The CDC/504 loan offers long-term loans at fixed rates for investments in machinery or real estate.
A 504 loan award is usually around $5 million. The SBA will guarantee 504 loans for 40 percent of the amount, and a commercial lender funds the remaining amount. Most SBA 504 loans have around 10- and 20-year maturity periods.
SBA Loan Requirements
SBA loan criteria differ based on which loan package you apply for. Most of the requirements that apply to all loan types include the following:
- Companies that are for-profit entities
- Companies that match an SBA small business definition within its industry
- Companies located and operating inside the US
- Companies that have been operating for a while
- Companies that have a three to five-year financial projection
- Companies that demonstrate a satisfactory debt service coverage ratio
- Companies that can prove they have collateral or other assets to secure a loan
- Companies that show their owner contributed their own time and money to the business
- Companies that show their owner has excellent personal credit history (FICO of 650 or higher)
3. Alternative Small Business Funding Options
Other ideas for small business financing that don’t fall neatly within the public or private lender categories include the following:
Crowdfunding helps small enterprises raise funds by tapping their friends, family, or individual investors to pledge funding. Crowdfunding platforms provide small business owners an online site to highlight their product and request funding.
Crowdfunding comes in three different models.
- Rewards-based crowdfunding offers an investor either a product or a service as a way to “reward” their investment.
- Equity-based crowdfunding allows a donor to become a co-owner of a business.
- Donation-based crowdfunding provides no financial return to contributors for their “donation.”
Merchant Cash Advance
Merchant cash advances provide another flexible funding option for a company that has consistent credit card or point of sale (POS) sales. Lenders send the borrower money in exchange for a percentage of these regular credit or debit card transactions. These lenders may insist on a short-term repayment schedule and charge fees for their services.
A merchant cash advance isn’t the same as a loan. Small business owners don’t have repayment schedules nor pay any monthly fees. A lender will usually receive roughly 5 to 15 percent of every transaction until the total advanced amount is repaid.
What Are Your Next Steps?
If you’re still a little nervous about small business financing options for your current or planned startup, then do a little more homework. Check the US Small Business Administration website to make sure your planned enterprise fits the definitions for a “small business.”
If you’re nervous about starting up a business alone, reach out to us. At Orcutt & Company, we know how to provide business planning services to our small business clients. Give us a call and we’ll show you how we can help you plan your next enterprise.