If you are a new business seeking finance, you will be keen to explore the different avenues available to prospective borrowers. It costs money to start a business, and your early financial choices could affect how you run your business for years to come.
Options for startups and small businesses include traditional investment loans, commercial loans, and grants – but what is the difference? To understand where investment, loans, and grants differ, we must explore the nuances of the terms “funding” and “financing” and what they both mean for new businesses.
Funding and financing: what’s the difference?
Although the two words are used interchangeably, there is a distinct difference between funding and financing. Funding is money provided by a company or government for a specific purpose, whereas financing is the process of receiving capital that you will eventually have to pay back, such as a commercial loan or investment loan.
Funding is usually given to a business or organization on the basis of an agreement. It doesn’t usually have to be paid back. This type of funding is also known as a grant. Although there are generally no requirements for companies to pay back the capital, those who receive the funding will still need to abide by certain contractual agreements. These might include charitable or environmental initiatives, as well as areas of research and scientific studies.
If it sounds too good to be true, that’s because, for most businesses, it is. Grants are limited to relatively small amounts of money. They also have highly strict criteria that you must fit if you wish to receive funding. If you do acquire a grant, you will be extremely limited in what you can use the money for. Funding can also come from public donations and is often provided by large community organizations to further education or awareness programs.
Financing is a cash advance provided to a business with the expectation of having it paid back. Unlike funding, the money must be repaid in full, plus interest, within a specified repayment period. Loan terms can be anything from a few months to 30 years. Commercial loans like these are often provided by institutions such as banks, venture capitalists, or investors.
Investors may agree to loan your business money in exchange for a cut of the profits. Some startups choose to approach so-called “angel investors” to help them launch. Angel investors are individuals who will loan small businesses money to help them raise the capital they need. Some investors will become silent partners in your business, whereas others will want a hand in how you run your organization.
Which is the best option for your business?
More and more people want to become entrepreneurs but starting a business can be near-impossible if you don’t have the funds. Thankfully, there is a range of finance and funding options for small businesses.
There are a variety of loans to be found for small businesses, including traditional bank loans, online loans, and Small Business Administration (SBA) loans. SBA loans are usually a good choice for small businesses, as the administration themselves partially guarantees them. This makes the loans low-risk for lenders and makes businesses with little capital more likely to qualify.
To qualify for an SBA loan, you have to be a for-profit business based in the U.S. with a net worth of under $5 million. Certain SBA loans have stricter requirements, and others you can only use for specific purposes such as real estate or equipment financing.
If you need a loan and you think you meet eligibility requirements, you can apply online on the SBA website. You must be prepared to include extensive documentation, such as financial history, cash flow projections for the next 3-5 years, credit history (your score should meet or exceed 700 in most cases), a solid business plan, information on business owners, and details on how you will meet your repayments. The same information – if not more – is usually required when you meet with investors and business angels.
Small business grants
If your business does not qualify for a loan, you may decide to look at alternative sources of funding, such as a small business grant. A grant could provide the cash advance you need to get your business off the ground, but they aren’t easy to come by. The government usually offers grants to small businesses engaged in scientific research and development, which can be obtained under the Small Business Innovation Research Program (SBIR).
SBA grants, for example, cannot be used for starting a business, paying off debt, or covering any operational expenses.
So why are business grants so tough to get?
According to the SBA:
“Any grants must be appropriated through Congress and The White House and are tied closely to specific agency agendas, such as the Department of Energy or the Department of Agriculture. To further complicate matters, the government has very stringent rules about who it provides grants to and what those funds can be used for.”
This makes sense, given that tax dollars essentially fund government grants, but it can be frustrating if you’re looking for capital for your business.
The difference between funding and financing needs to be made more transparent for businesses to understand their options better. Although grants like government funding and public donation have strict criteria, they are a great funding source for certain types of business, such as those engaged in scientific research.
However, most small businesses are better off looking in the direction of commercial loans to help them meet their organizational needs. Angel investors can also provide a smart route to business financing, but they are in stiff competition.
Certain types of business financing (such as commercial loans and equipment financing) are ideal for helping new businesses grow and expand. To learn more about how to apply for a small business loan, you can find your nearest SBA lender online or explore the SBA website. Here you will find extensive details on your loan and grant options, as well as eligibility criteria and the documents needed to support your application.