Small businesses play an important role in the economy, but many small business owners worry about their access to capital. Unlike big corporations with easy access to diverse funding sources like stock and bond markets that offer larger sums of money, small businesses have limited financing options for significantly less money and face stricter requirements.
Access to funds is a critical factor in building and scaling a small business. Capital is necessary for initial startup costs, management of daily operations, or funding an expansion. Fortunately, small business owners now have access to more financing options than just the traditional term loans offered by banks.
Below are several of the alternative financing options available for small businesses.
Debt Financing
Small business owners can borrow capital from external lenders, typically banks and other non-bank credit providers. These lenders do not acquire ownership or a stake in the business, but the loan must be repaid over time with interest.
Traditional Bank Financing
A majority of small business owners seek out loans from small and large banks, which provide term or installment loans, lines of credit, and other standard loan products.
These traditional financial institutions have tighter credit standards and their loans can be harder to qualify for. Approval and loan terms depend on the business owner’s personal creditworthiness and the business’ assets and profitability.
As such, bank financing is best for established businesses with strong credit scores and collateral. Examples of bank loan products small businesses can avail of include:
- Term loans: You receive a lump sum of cash that is to be repaid over a set period with a fixed or variable interest rate.
- Business lines of credit: This is a revolving credit that allows you to draw funds as needed and only pay interest on what you use.
Non-Bank Financing
Because it can be hard to get approved for a bank loan, more and more small business owners are looking toward non-bank financing for their funding needs. These options often feature faster approval times and more lenient credit requirements than traditional banks.
- Credit unions: Offers flexibility, personalized service, lower fees, and competitive interest rates compared to traditional banks.
- Equipment financing: The equipment itself serves as collateral for the loan, which can preserve cash flow by spreading the cost of the equipment over time rather than paying the full amount upfront.
- Invoice factoring or financing: Selling your unpaid invoices to a lender at a discount to get immediate cash flow.
- Merchant cash advances (MCA): An advance against future credit card sales. It is generally fast but carries higher costs (a fixed percentage of daily credit/debit sales).
- Revenue-based financing: Repayments are tied to a percentage of your monthly sales. It offers flexibility during slow months.
Alternative Financing
Aside from business debt or going into loans or owing credit, small business owners can also tap into alternate funding sources. These “self-funding” alternatives give you full control over your small business but you also take on all the risk yourself.
- Personal savings or bootstrapping: This entails starting a business with minimal capital and relying on personal savings (rather than external investment) along with operating revenue to continue business operations.
- Personal credit or credit cards: Personal or business credit cards used for business purposes can serve as an alternative for cash liquidity and provides financing when small business owners cannot pay in cash.
- Investment from friends and family: Often referred to as “FFF lending,” it provides quick access to capital that offers flexible and cheaper terms. However, it relies on your personal network for funding, which poses a risk to your personal relationships.
Equity and Community Funding
Equity and community funding prioritize partnership and social impact over standard debt. The former involves the sale of a portion of ownership in the business, which means you can secure capital without the immediate pressure of repayment but at the cost of sharing future profits and decision-making power with investors.
- Angel investors: Known for investing in startups that demonstrate high-growth potential that may not qualify for large bank loans or venture capital.
- Venture capital: Focused on investing in small businesses with high-growth potential, innovative technology, or scalable business models.
- Crowdfunding: Raises funds from a large number of people, who typically receive a gift (often the product or other special perks) as thanks for their contribution and don’t expect a share of ownership or financial return for their investment.
Community funding, on the other hand, is designed to support underserved markets or niche industries that have potential impact on the local economy. This can be a vital lifeline for small businesses who prioritize community integration over financial growth.
- Community development financial institutions (CDFIs): Non-profit, mission-driven lenders that provide capital and financial services to small and micro-enterprises in underserved, low-income, and minority communities.
SBA-Guaranteed Loans
The U.S. Small Business Administration (SBA) does not lend money directly but it guarantees loans made by participating lenders. The SBA partners with financial institutions, such as banks and credit unions, to provide loans to small businesses. This setup reduces the risk that lenders take on, which enables them to offer better terms to small business owners.
In addition to providing access to small businesses that might not qualify for traditional financing, SBA-guaranteed loans also offer lower down payments and longer repayment terms.
Some examples of the SBA loans small businesses can avail of include the following:
- SBA 7(a) Loans: The SBA’s most popular program, it is used for working capital, equipment, and debt refinancing (up to $5 million).
- SBA 504 Loans: A long-term, fixed-rate loan that’s specifically for major fixed assets like commercial real estate or heavy machinery.
- SBA Microloans: Smaller loans up to $50,000 provided through nonprofit community-based intermediaries.
Federal and Private Grants
Unlike loans, small business grants do not require repayment, but they are highly competitive.
- Federal grants (grants.gov): Often industry-specific, such as the SBIR (Small Business Innovation Research) program for tech companies, and often focused on innovation, research, and technical development rather than general operating expenses.
- Private/corporate grants: Programs from companies like FedEx and Visa, foundations, and organizations, often with more specific criteria related to industry or business owner demographics (e.g., grants specifically for women-owned businesses like IFundWomen and WomensNet).
- State and local grants: Offered by regional economic development agencies to stimulate local economies, encourage local job growth, foster innovations, or support specific demographics.