The Challenges of Financing a New Small Business

While there are more options for financing a small business than ever before, there are still some obstacles to financing a brand new business. Nevertheless, it is possible for a company less than a year old to access capital and get off the ground—though it might not be where you're likely to look.

Before you start your search, there are three questions you should ask yourself:

  1. What do I need the money for? There’s a myth that all a startup needs to build a successful business is capital. There are situations where the influx of capital can be an important part of success, but during the first 12 months, it’s critical to make sure the business balances the time spent chasing capital and the time needed to build a strong business foundation. Understanding the business need for capital will help determine whether or not pursuing it is worthwhile.

    The Federal Reserve reports the average small business owner (which includes established businesses) spends 33 hours looking for and applying for a small business loan. Finding startup capital is likely to take even more time—so looking in places where the odds are more favorable is another reason you should ask yourself “What do I need the money for?”

  2. How much money do I really need? The business need you’re trying to fill can help determine how much capital you should be looking for, as well as where to look. Any time you borrow, there are expenses associated with the loan, so borrowing more than you need can incur extra fees.
  3. Can I use this opportunity to build credit? Although there are situations where a startup or early-stage business might qualify for a substantial business loan (a highly qualified borrower might find success with an SBA-guaranteed loan for example), most of the time the capital available to very early stage businesses will be in smaller loan amounts or by way of (30 or 60 day) payment terms offered by suppliers. Although this might not be a $100,000 business loan, this is actually a good opportunity for new small businesses because it gives them the opportunity to focus on building a strong business credit profile in the early years with
  4. How strong is my personal credit profile? Although a business owner’s personal credit profile isn’t necessarily the best measure of how they’ll repay their business debt, it will likely be part of the equation, especially when the business is young and has not yet established a business credit profile.

Asking these questions before you start looking for a small business loan will help you determine if you really need to borrow money and whether or not you’re in a financial position to actually find success with a lender. If the answer is yes, there are options.

The SBA

The Small Business Administration isn’t a lender, but they do offer a loan guarantee program through participating banks and credit unions. For most SBA programs, a lender requires a strong personal credit profile, collateral and the ability to demonstrate a source of income to make loan payments.Interest rates and terms are generally favorable for those who meet the criteria, but if your personal credit is weak and you don’t have any collateral, it will be difficult to qualify.

Micro-Lenders

If your business is able to leverage a small amount of capital into something big, a micro-lender might be a good option. The SBA offers a microloan program, as do other lenders who specialize in loans in the $5,000 to $50,000-dollar range (the SBA considers any loan under $50,000 a microloan). Some micro-lenders are willing to work with early stage business owners by offering smaller loan amounts and include mentoring and advice to help the business get up and running.

Crowdfunding

Crowdfunding is not borrowing—it is motivating a group of people to contribute to your business (or business idea) because they believe in what you’re trying to do. The most popular type of crowdfunding campaigns involve some kind of perk to those who contribute—maybe an early version of a new product, a T-shirt or something else of value. If you have a product or business that has the potential to get a lot of people excited about it, and you are willing to put a little elbow grease into creating a pitch that will motivate them to contribute to your business, a crowdfunding campaign might be a good choice for you.

There are both national equity crowdfunding laws, as well as state-specific laws in some instances. Be sure you fully understand these laws before embarking on a campaign. 

If you decide to go this route, you should also spend time on crowdfunding sites to learn about which campaigns are successful and which fail. Many non-equity crowdfunding sites take an all-or-nothing approach. In other words, if you don’t meet your goal, you don’t get anything. Those who are successful seem to treat the campaign in the same way they would treat pitching an investor.

Friends and Family

While a loan from a family member or friend might not be the first choice for many entrepreneurs, there are a lot of small businesses that benefit from this type of financing. And, although it might be tempting to be cavalier in how you approach borrowing from a family member, many business owners find that formalizing terms and treating a loan from a friend or family member the same way they would treat any other loan makes it a lot easier to attend Thanksgiving dinner and other family gatherings.

Although financing an early-stage business can be challenging, getting that first year under your belt can make a difference. Many online lenders will offer loans to healthy businesses which are earning revenues and have reached their first birthday. The choice isn’t really one or the other, but answering the first three questions above will help you determine where it makes more sense to focus your efforts on pursuing capital or building a credit profile.