A “How to” Guide for Different Types of Funding for Business

To start and manage a successful business, you will most definitely need funds. According to reports, a good number of businesses close up after a few years; two out of ten within the first year alone. Have it in mind that one of the notable reasons businesses fail is because they do not have the necessary financial resources to continue operation.

Most often, businesses take years to become profitable and within those periods, they rely on funding opportunities to keep them afloat. There are numerous options when it comes to seeking funds to start or run your business.

The type of funding your business needs will most often depend on numerous factors such as the stage of the company, business strategy, track record as an entrepreneur, etc. It is also necessary you know the options that are available since they will reach out for funding when you need it.

There are many funding paths to choose from. Understanding the pros and cons of each can help you make a more informed decision for the future of your business. Below are some of the most common funding options for entrepreneurs, along with their pros and cons.

Different Types of Funding for Business and Their Pros and Cons

  1. Bank Loans

Banks are known to provide a wide range of loan types to business owners who meet their qualifications. These loans tend to work just like personal loans and you will be charged interest on top of the loan amount you’re provided.

Payments will also have to be made over a specified period and are deducted automatically from your business account. Every bank will ask to see your business plan before even considering a financing arrangement. They will also evaluate your business plan to understand your needs and make a decision on whether to finance you.

Pros
  • Different lending options available to meet your needs
  • Low, fixed interest rates
  • Build your business credit
  • Flat-cost, predictable monthly payments
Cons
  • Extensive wait time to obtain funds
  • Strong personal and business credit is necessary
  • Daunting paperwork process
  • Collateral requirement

Sources: Wells Fargo, Chase, and Capital One, among others

  1. Personal Finances

Reports have it that over 65% of entrepreneurs start their businesses with personal or family savings, or by leveraging the income from a primary job or spouse’s job. Although using personal finances to start and grow a business with little or no outside cash is very much possible for certain types of businesses, have it in mind that other forms of business will require more capital than you can personally afford.

Pros
  • Ensures complete control over the business
  • Can grow your business at your pace
Cons
  • Many do not have the personal capital to self-fund their business
  • Growing the business would be much slower

Sources: Savings, selling possessions, getting a mortgage, or remortgaging.

  1. Family & Friends

According to statistics, this is the first outside capital a business owner considers. Family and friends already trust the entrepreneur personally and will most likely be willing to provide capital at very favorable terms. The investment will have to be seen as a debt if the money is to be repaid or equity if the investors become part-owners of the business.

Pros
  • This sort of funding is always made on good terms for the entrepreneur and business.
  • It is structured to be supportive and flexible, even if things don’t go as planned.
  • May agree to a longer repayment period or lower return on their investment than formal lenders.
Cons
  • There is always a chance for things to get complicated when you inculcate a financial layer into a personal relationship.
  • Your friends and family may not have the means or resources to provide this sort of funding.
  • There are times when family and friend funding may not be substantial enough to continue growing the business.

Sources: Spouse, Friends, Colleagues.

  1. Business Overdraft

In this form of funding, you get into agreement with your bank on a set limit you can withdraw anytime you need extra funds. It is one of the most viable ways to manage cash flow and guarantee day-to-day expenses or emergencies.

However, you mustn’t rely on it as a long-term funding solution. Since there is interest involved coupled with fees to pay when using an overdraft, you might want to consider other sources of funding. Interest on overdrafts is typically charged on the amount borrowed and calculated daily. To keep costs down, you should always try to get back into the black as soon as possible.

Pros
  • Flexibility
  • Retain full control of your business
  • Managing cash flow
  • Provides emergency cash
Cons
  • Banks charge for extending your overdraft or exceeding your limit without authorization
  • The lender retains the right to ask for repayment of your overdraft at any time
  • Exceeding your authorized overdraft limit can negatively impact your credit record
  • Lenders can reduce unutilized overdrafts at short notice
  • Interest rates for overdrafts are known to be higher than loans or credit cards

Sources: Capital One 360 Checking, Ally Interest Checking Account, Discover Cashback Debit Account, Axos Bank Rewards Checking.

  1. Crowdfunding

Crowdfunding is one of the fastest ways to raise finance with no upfront fees. It is most often used by startup companies or growing businesses as a means of sourcing alternative funds. It is also a creative way of sourcing funding for new projects, businesses, or ideas.

It also helps businesses cultivate a community around their products or services. You can leverage the power of the online community to obtain valid market insights and access new customers.

Pros
  • Little or no financial risk
  • Opportunity to validate your market
  • Complete control over your business
  • Creates momentum
  • Can accelerate your business and create a network effect
  • Community around their products or services
Cons
  • Time-consuming and expensive
  • Saturated market
  • Negative feedback can be rough.
  • Only suitable for consumer-facing products
  • Doesn’t “find investors” for you.

Sources: iFundWomen, Kickstarter, Indiegogo Pebble, SkyBell, and the Coolest Cooler.

  1. Angel Investors

These are investors who use their personal money to invest in startup companies. They are willing to take a risk on a startup or young business they feel confident in and are less bothered with personal credit, business history, collateral, or sales. Businesses that show very viable potential to succeed are very well positioned to attract angel investors. However, some pros and cons come with this sort of funding:

Pros
  • No cost to your business
  • No repayments
  • Expert mentoring
  • Enhanced credibility
Cons
  • You will give up equity in your business:
  • Possible restrictions on how finance is used
  • Reduced founder control
  • Finding an angel investor can be time consuming
  • They expect rapid growth

Sources: AngelList, Angel Capital Association, Gust.

  1. Business Credit Card

Business credit cards tend to work in the same way as personal credit cards, except that the card is in your company name and not in any way intertwined with your personal finances. This form of business funding is also based on your company income, and not on your personal income, and this most often means you can borrow more.

However, just as with business bank loans, they also come with interest rates and limits that differ depending on your business and personal credit scores. Note that the larger your business income and the longer you’ve been in business, the higher the credit limit and lower your interest rate.

Pros
  • You’re not required to give up shares in your company
  • Ensures that you can manage cash flow
  • Gives access to immediate funds in the event of an emergency
  • Credit cards offer benefits such as cash back on purchases, free travel insurance, 0% interest periods, and reward points
  • Most lenders offer extra cards that can be issued to multiple staff to pay for expenses
Cons
  • Readily available to new businesses
  • Potentially high-interest rates
  • Cash withdrawals are expensive
  • Providers charge an annual fee for each card you have

Sources: Bank of America, American Express, etc.

  1. Small Business Grants

This is another very effective source of funding for small businesses and startups. Have in mind that there are hundreds of grants to pick from. Note that some grants are ideal for growing businesses, while others are perfect for an established business.

You can also find programs meant for highly niche startups. Each grant provider has strict criteria for anyone applying for funds. And in most cases, you will need a detailed business plan that validates your idea.

Pros
  • No repayment necessary
  • A vast range of options to pick from
  • Enhanced credibility
  • Free mentorship
Cons
  • Low financial assistance
  • Complex application and approval process
  • Restrictions on spending
  • Strong competition

Sources: Small Business Development Centers, Regional SBA offices, Local incubators.

  1. Venture Capital

This is a step up from angel investment. While angel investors seek to invest their money in a business, venture capitalists tend to work on behalf of venture capital firms to invest money from numerous other sources including corporations, individuals, public and private pension funds, and foundations.

In addition, while angel investors may be looking at investing between £15,000 to £2 million in a business, a VC firm investment wouldn’t invest in anything under £1 million.

Pros
  • Access to a large amount of capital
  • They invest in helping the business grow and provide the advice and experience to support
  • There are no fees or charges associated with securing angel investment
  • You won’t have to repay the investment
Cons
  • You will have to give up equity in your business
  • No guarantee of growth
  • Intense competition
  • It may not be suitable
  • Pitching can be challenging

Sources: Next Frontier Capital, Greycroft, Andreessen Horowitz, etc.

  1. Government Small Business Loans

In the United States, government loans are provided via banks and credit unions that partner with the Small Business Administration (SBA). The SBA is more or less a U.S. government body that strives to provide extensive support for small businesses and entrepreneurs.

Note that each loan provided by a government-backed guarantee offers serious credibility, especially since the lender knows that even if you default, the government will sort out the balance.

Pros
  • You still have full control of your business
  • Unsecured loan
  • Flexible repayment terms
  • Fixed interest rate
  • Support all through the application process
  • Free mentoring
Cons
  • Not suitable for every business
  • The fund may not be sufficient
  • Personal credit checks
  • Default charges

Sources: SBA and other banks and credit unions that partner with the Small Business Administration (SBA).