Many small businesses fail in the first few years, and one reason why is running out of money. If you’ve ever watched the television shows Dragon’s Den, Shark Tank or The Apprentice, you will know that one of the most important ways to achieve business success is to get the finances right.
That means thinking hard about how you’re going to fund the business both at the start, and as it grows. Applying for a loan without proper preparation is why many small businesses are turned down.
It is important to understand how bankers decide whether your business is creditworthy or not.
According to Intuit: “Bankers lend on the five Cs of credit: character, collateral, cash flow (enough to service the debt), credit, and conditions. If cash flow and credit are weak, then you have to accentuate character, collateral, and conditions.”
Take stock of where you stand on these five factors. Over time, each of these can be improved. How you present yourself and your information can mean the difference between approval and rejection.
Reasons SmallBiz Loans Get Rejected
Small Business Trends has previously discussed ways to get your business loan denied. These are the most common:
- Bad credit or no credit
- Lack of collateral
- Weak cash flow
- Lack of preparation
- Seeking small loans
- Risk-averse banks
The number one priority is better preparation. Having accurate, current financial statements is imperative. Staying on top of receivables and turning inventory quickly make your business a lower risk.
Here are some funding sources for you to consider, with the pros and cons of each.
Finance Your Business
1. Your Own Credit Facility
Many small businesses start by using the credit facility already open to them: their banking overdraft protection. On the plus side, it’s quick and easy to arrange an overdraft plan with a bank. You only pay interest on the money you actually use, and there won’t be a penalty if you pay it back early.
But there’s still a danger with this form of funding. If you exceed your overdraft limit, fees can be steep, and your bank could decide to withdraw the facility if you no longer meet the criteria for having it.
If you’re wondering about funding your business by using your credit cards — don’t. Not only is the interest high, but if things don’t go as you expect in your business, you could find yourself in crippling debt and under huge amounts of stress, plus you risk losing everything if you are unable to repay the debt.
2. Attracting Investors
Getting external investors (which is what Dragon’s Den and Shark Tank hopefuls want to do) is another possible way to fund your small business. The advantage is that you won’t have to repay the investment because investors gamble on your business being profitable.
But the disadvantage is that you’ll need to give away a share of your business in order to make it worth their time and money. Think carefully about whether you want to do this. If it’s important for you to retain ownership of the business, this may not be the right route for you.
This example of using Venture Debt to keep more of your company is offered in Four Creative Strategies for Raising Business Capital:
Venture-debt is a great way to lower the cost of accessing capital by leveraging both debt and equity. For example, a traditional round of funding might require you to give up 20 percent of your company for $100,000 in investment. With venture-debt, you could negotiate a deal where you get access to the $100,000 you need, but instead of 20%, you’ll only need to give up 8 percent of your company. Of course, the $100,000 is treated as a loan and will need to be paid back with interest.
One way to find the right investor is to use a peer-to-peer investor matching service. It’s worth noting that if you decide to go the investment route (and for most other sources of funding), you will need to show a business plan that indicates expenditure and projected income over several years.
Finally, remember that you can use more than one funding source to support the development of your small business. Weigh the pros and cons carefully and decide which combination of options makes sense for your current situation.
3. Business Loans
You will definitely need a business plan to get a business loan from your bank. If your business plan is sound, you may be able to get the money you need. The advantage of a business loan is that you will have that money for a specified period and you won’t have to give away any of your business to get it.
But the risky part is that you have to secure most loans using one of your assets. If you get a business loan with your home as security and then are unable to repay it on schedule, you risk losing both your business AND your home. That’s why it’s a good idea to review the type of small business loan, terms and fees before you sign on the dotted line to make sure you are getting the best deal.
A major challenge for new businesses is getting a loan with no credit. There is a white paper available for free download in How to Get a Small Business Loan with No Credit that offers these tips about SMB credit scores and working capital loans:
- When businesses have no credit or bad credit, working capital loans are easier to get than other types of loans
- Having filed bankruptcy in the past does not disqualify applicants from obtaining this kind of loan
- More flexibility in how you use the money
- No collateral is required
- Simpler application process with faster approval
Taking out a loan because of a downturn in business should only be done after careful analysis. Businesses cannot typically borrow their way out of a decline, so cutting expenses or making other changes may be necessary.
4. Small Business Credit Cards
Small business credit cards can be used to smooth out cashflow, stock up on seasonal inventory, or take care of unexpected expenses. If you tend to pay your credit cards off every month, this could be a viable solution for your business.
MoneySavingPro researched major business credit cards and compares various offers here. They point out that the perks provided by some business cards could be financially beneficial if they suit your business:
The [Chase Ink Cash Business Card] cash back rewards system is fairly competitive. Each year the first $25,000 you spend on business needs like office supplies, mobile phones and land-line service and even cable TV and internet will earn you 5% cash back. You can also earn 2 percent on the first $25,000 each year in purchases made at restaurants and gas stations and 1% on all other purchases.
Other cards including the Capital One Spark Cash have higher cash back rewards for all purchases. If you always pay off your card every month, the American Express Plum Card could be your best choice.
Having credit cards can be very tempting, causing many to spend more freely than they would have if they were parting with actual cash. Before you spend, make sure you know the risks. In their comprehensive write-up on The Pros and Cons of using Credit Cards to Finance a Small Business, Credit Suhaar advises:
Do make sure you keep your card secure, as not every business credit card covers the company against misuse or fraud. Ensure that no employee uses the card to charge up expenses of a personal nature, or for any fraudulent or unauthorized purchase.
They quote statistics indicating “a whopping 64 percent of small businesses had signed up for card usage” because credit cards can be easier to acquire than bank loans, especially if you have decent business or even personal credit scores. They also require less paperwork.
Credit cards can be useful, but read the fine print and make sure the low rate isn’t for a limited time. Compare companies, and don’t be afraid to switch if costs increase in spite of paying the card off in full each month or at least making the minimum payments on time.
5. Get a Grant
Grant funding is another option for small businesses. Government agencies and others often give grants to support projects in a particular area. While these are often for future projects, if the right project is part of your business then you could qualify.
The advantage of getting a grant is that you won’t have to repay the money nor will you have to part with a share of your business. However, the application process is time-consuming and many grants require you to supply some of the project funding.
Crowdfunding has become a popular way to get startup funding. Popular sites include Kickstarter, IndieGoGo, and GoFundMe and there are many others. To do this, set up a profile on a crowdfunding site, provide information about your business and offer rewards depending on the funding given. A good video and plenty of networking are essential to make this work.
Some businesses have raised hundreds of thousands of dollars by using crowdfunding sites. With crowdfunding, you don’t have to repay the money and you retain control of your business. But some sites require you to reach the full funding target or you don’t get any money, so be aware of that when choosing this route.
Loan Photo via Shutterstock