Businesses require a lot of capital at the inception stage. Research reveals that success favours businesses that employ savings to take off the ground. In the future, they will experience fewer cash flow problems as compared to businesses that rely on external financing factors. However, it is not guaranteed that such businesses will manage to hit the ground running in tough market conditions.
Every business varies in size. Their needs differ. Maybe you had enough money to start your business, but you may need more funds as your business grows. No matter how well-crafted your business plan is, it will take time to reach the breakeven point. Despite generating revenues, you might need money for your business.
Effective ways to finance a business
Here are the ways to finance a new business:
Estimate the cost of your business
Businesses need a lot of money in the beginning. Though your business is small in size, you will still need money for advertising, market research, and training programmes. When these costs are added in, they become a lot. Chances are, you do not have reserves to dip into.
Other than them, take into account costs such as utility bills, rent, insurance, and salaries. These recurring costs add a burden because they are permanent expenses regardless of profitability.
Certain expenses are fixed, whereas others are variable. The latter might be up and down depending on your business operations. Club all these costs to know how much money you need upfront.
Bootstrapping
Bootstrapping is the best option to fund a start-up. It involves employing savings and revenues to fund business operations. This is the most inexpensive financing method as no interest is to be paid. At the outset, you will dip into your savings, and once revenues start generating, you will start utilising them for your business.
However, bootstrapping requires careful planning of cash. Despite revenues, you must have earmarked cash to access large funds.
Equity financing
Small businesses sometimes need large funding. Here comes the role of equity financing. It is a process of raising money from investors in exchange for part of ownership. Equity financing is absolutely different from debt financing because here you are raising capital. You are not supposed to pay it back. You would rather be sharing a portion of profits and ownership with them.
At the time of considering equity financing, you should carefully calculate your comfort level with losing ownership. They will be involved in the decision-making process, and you might not be able to make a decision by going behind their back. Both parties must reach a mutual agreement. Do not forget to carefully take stock of the upsides and downsides of equity financing.
Small business loans
Taking out a business loan is not a cinch for start-ups. Lenders will generally require you to prove that the business is profitable. If your business has just reached the breakeven point, they will expect you to submit a business plan. A detailed plan will be required that talks about the following points:
- Your target audience
- Market scope
- Market segment
- Marketing methods
- Projected profits
- Timeline for profit realisation
- Alternative repayment plans
Bear in mind that these loans charge high interest rates, and the borrowing sum will not be too large. They follow difficult acceptance criteria. You must have a good credit score. Since startup loans are unsecured, lenders might ask for a personal guarantee.
Instalment loans
Instalment loans can also come in handy when you need a small amount of money. They are similar to start-up loans. They are also paid down over an extended time period. However, these loans are offered to businesses that have started generating profits. In order to be eligible for these loans, the following conditions must be met:
- Your business has been trading for at least two years.
- Your business must be consistently making profits.
Qualification of these loans requires a good business credit rating. Your personal credit score will be taken into account, too. Since these loans are collateral-free, lenders will ask for a personal guarantee to minimise their risk in case of default.
Use a business credit card and line of credit
Profitable businesses can apply for business credit cards and lines of credit. Lenders will carefully determine your repayment capacity, as it serves as the basis for deciding on a limit. Business credit cards work the same way as personal credit cards. Money is to be paid in one feel swoop on the due date. Interest-free cards are also available for businesses with high profitability.
A line of credit works differently. Here, you are not supposed to pay back the full amount. Part payments are acceptable as interest is accrued only on the outstanding balance. Once the part payment is made, you are eligible to re-withdraw it as and when you need.
Do not rely on personal credit cards for your business needs, as this dangerous game could trap you in an ongoing debt cycle. If you want to use them for your start-up, make sure that this is a one-off expense and you do not exceed more than 30% of the credit card limit.
Merchant cash advance
Merchant cash advance enables you to borrow a lump sum based on your debit and credit card sales. However, your business has been operating for at least a year, and there has been a consistent sales record. Lenders may want to access the record of at least the previous six months. This is not a feasible financing option for start-ups that have just reached the breakeven point.
Borrow from friends and family
For small start-ups where you need a paltry sum, you can think of seeking financial help from friends and family. Set payment terms so they know you are serious about paying back money.
To wrap up
Financing a business does not have to be complicated if you understand the advantages and drawbacks of all funding options. Having clarity of how each loan works will help you choose the right financing.
