In 1998, two college kids in their mid-twenties came up with the idea of a page rank system for websites. Working out of their garage, the kids approached several technology firms to help fund their idea, but all of them declined. Desperate to continue funding their education, they even put the innovative new system up for sale. The internet giant “Yahoo” declined to purchase the idea at an asking rate of one million dollars. Ten years down the line, that company went on to become the face of the internet as we know it. Google now a valuation of more than $500 billion.
Though this one had a happy ending thanks to some sound business sense and luck, not all small businesses see the same fate. Imagine just how many brilliant ideas like Google are lost everyday thanks to investor reluctance in providing loans for starting a business. Thankfully, things aren’t as bad right now as they were back then. The internet has given way to several innovative funding platforms, which we will be discussing in this article along with a few others. Here are six ways to get startup small business funding.
Small Business Funding Through Equity Financing
Equity funding basically means giving up some percentage of your ownership in return for funding. Most successful companies use this option by going public and selling shares on stock exchanges such as the NYSE. However, these companies have a nine digit valuation figure, so we won’t be going in that direction.
Small business funding can be acquired by selling ownership stakes to friends, family or external investors. The advantages of equity funding are numerous, the major one being that the proprietor shares no liability beyond the scope of the business. So if the business goes bankrupt, remaining assets will be divided among the owners equally. But there’s a flip side too. Since the business will be jointly owned, investors will have a say as to how the company should operate. This can cause a clash between management and owners commonly known as the “agency problem”.
Partnerships are a form of equity financing where the controlling interests in a business are divided between two or more people. It is not necessary for partners to bring in just capital investments. They may also invest other resources such as machinery, equipment and even expertise.
Partnerships do solve the agency problem to some extent as fewer people are involved in making business decisions, resulting in a more coordinated effort. However, partners do have unlimited liability, so any losses would have to be covered by the partners’ personal assets. Limited partnerships are designed to work around that, but they are costlier to design. Since limited partners are really just investors, numerous annual meetings may be required to maintain the partnerships.
Venture Capital (VC)
Venture capital is a practice of providing business capital funding early on to take a new business to the next level. They typically look for businesses with profit-making potential and invest huge sums in return for ownership interests. While this may seem tempting on paper, venture capital firms are generally looking to acquire majority ownership interests, so you might just end up working for the company you started.
The new kid on the block, crowd funding platforms allow small business owners to pitch ideas to investors all around the world. Kickstarter.com is perhaps the most famous crowd funding website, managing to fund revolutionary new ideas such as the Oculus Rift. The investor rewards may be product based, so it’s not necessary to give up ownership interests. However, crowd funding requires a lot of resources initially in order to properly market the idea to investors. Also, if the funding target isn’t met, all the pledged money is returned to the owners. In that case, all that time and effort goes to waste.
Banks have traditionally been the most popular source for small business funding. The great thing about banks is their convenience. There’s bound to be a branch within a 2 mile radius of your business. However, getting loans isn’t as easy as it once was, especially since the 2008 financial crisis. It has become next to impossible to acquire loans for people with bad credit. Even if they do qualify, some banks might quote rates as high as 5% a month. Bank loans are also securitized, meaning you’ll have to back the loan up with some sort of asset as collateral.
The Small Business Association was established to help provide the best loans for small businesses. With interest rates as low as 3% monthly, they might seem like another tempting option. However in the long term, they can be quiet costly. The aforementioned interest rate amounts to 36% per year! And with recent reports, it seems increasingly difficult to qualify for SBA loans. Like banks, their loans are also securitized, so you’ll require collateral or a solid business line of credit.
Accounts Receivable Financing
Accounts receivable financing, or factoring as it’s generally called, allows for people to get quick funding for small businesses by transferring their receivables (the amount owed by customers to the business) to a factoring firm with some reduction. For example, if a business owed $5000 by a customer, the business may sell the receivable to a firm for an immediate cash payment of $4500(assuming a 10% factoring rate). Some factoring houses, such as Carter Financing Corporation, may even charge rates as low as 1%. The advantages of this type of financing are obvious; immediate cash payout for the business, no collateral required, no lending criteria. The last one makes it an excellent option for obtaining business loans for people with little or bad credit.
Remember, financing will require you to bear some costs. Evaluate all your options and select the best one that fits your requirements.