Business Financing Options for 2022
Small Business and COVID Small Business Finance in the Era of Falling Interest Rates
It’s no surprise that COVID-19 had a monumental impact on small businesses. During the early days of the pandemic, many businesses were forced to abruptly close their doors without a clear indication of when business and life would resume to normal. According to a study by Guidant Financial Small Business Trends, only 63% of respondents’ businesses were profitable in 2020, compared to 78% in the previous year. Despite the uncertainty and loss of profitability in 2020 there are many reasons for optimism in 2021. The financial relief from programs such as Paycheck Protection Program (PPP) and Economic Injury Disaster loans (EIDL) along with a vaccine availability to all Americans is creating a more positive outlook for the future of small business. Guidant Financial reports – 49% of small business owners answers they were either somewhat or very confident about the future of small business despite the pandemic..
Building a Small Business
Many small businesses begin with just an entrepreneur's dream. An aspiring entrepreneur may want to turn a passion into a business. That might be cooking, gardening, renovation, photography, or dog grooming. It’s incredibly rewarding to build a business from just a passion and an idea, turning it into the sort of venture that puts you in complete control of your life and your finances.
Some other entrepreneurs want to be a part of a bigger, more established team. They may opt to take a safer route by purchasing a franchise, which comes with an established brand and proven operational systems. Franchises are also available in every industry or interest. Fitness centers, restaurants, hotels, and retail locations all offer lucrative opportunities for smart business owners. No matter how the business is conceived, built, or grown, owning your own company is often an important part of the American dream.
Entrepreneurs are also becoming increasingly diverse
As the relationship between traditional employers and employees evolves, more and more types of people are becoming business owners for any number of reasons. After all, the American worker’s average tenure at his or her job is now about 4.1 years, according to the Bureau of Labor Statistics Employee Tenure Summary (January 2020 ). People are leaving jobs quickly for greener pastures, and for many people, that means ownership.
It is not uncommon for someone who has been terminated from their job to then take the opportunity to start a business. They may have dreamed about being the boss for some time, but were unwilling or unable to assume the risks associated with starting a business while still gainfully employed. Often, this type of entrepreneur launches an enterprise in the same field they have always worked in and vows to do it better.
In addition to diverse reasons for building companies, the community of small business owners is growing more diverse as well. Guidant Financial found that from 2017-2018, there was an 82% increase in minority business ownership mostly attributed to African American and Hispanic business owners. And while women owned only 4.6% of all business is in 1972, today, 42% have a woman at the helm. And those companies are growing at a faster rate than others, according to the the 2019 State of Women-Owned Businesses Report commissioned by American Express
There's also a wide range of ages for people who are interested in running their own company. According to a study by Guidant Financial, over 54% of business owners it surveyed were 50 years or older. Many of these entrepreneurs are using their small businesses as the crowning achievement of a successful career.
Financing and Business Loans
It doesn’t matter if it’s your first company or tenth, where you live, who you are, or how far you’ve come with your current venture. You need to know as much as possible about financing. Understanding the world of business loans can lead to a smooth startup, and identifying the signs of when you need more funding-when you need more funding can make a big difference in the cost of capital.
Once you're committed to starting a business venture, you’ll need to take the time to write a business plan. A good business plan gives anyone reading a window into what your company is all about and what you expect the future to hold. The business plan will explain what the business is, who the customers are, where it’ll be located, when it will operate, and show that you understand why the answers are what they are.
Always remember that a business loan is a vote of confidence from a lender. If you receive a business loan, the lender is telling you that they believe you’ll be able to repay the loan and interest in full and on time. And they’ll base that decision on many factors, from the expertise of those running the company, your financial data, and the holistic vision you lay out in your business plan.
Typical Start-up Costs
Going back to the Guidant study, almost half of the respondents surveyed reported that they used less than $50,000 to start their company.
"Many expect business ownership to be a very costly venture, and while it can be, almost half of all business owners surveyed said they used less than $50,000 total to acquire or launch their business. Another 18 percent spent up to $100,000," according to the study.
Starting your own company doesn't have to completely drain your bank account if you plan it well. But no matter how much you spend to get your company started, you'll need funding to keep the business going long after launch day. While $50,000 may seem like a small sum in comparison to the income that a business can bring in for years to come, it can still be difficult to pull together a big lump sum of money like that to get started.
Plan Ahead for Capital Needs
With the Federal Reserve lowering interest rates and the stock markets on the rise, right now is a perfect time to consider when you may need capital in the future. Because if your company’s ducks are in a row - financial data double-checked and readily available, loan payments made on time and in full - this is a great time to secure funding if you can predict that you’re going to need additional cash on hand. The markets are looking strong, and you can take advantage of better terms and lower interest rates now instead of hoping things continue to improve.
Deciding how much to borrow
Naturally, you need to have a well-thought-out idea of just how much money you want to ask for before you approach a lender. You’ll also need to justify the requested amount by showing the funding company the return on investment. (ROI) in your pro forma financials or business plan.
The business plan will describe the elements about the company and management team that will make sure the firm can achieve the target ROI. Draw upon research, along with your expertise in the industry, to project a budget that outlines how much money you believe will be required to start, continue, or complete any necessary projects and provide documentation that backs up your projection.
Ask for more than you've estimated will be necessary. Inevitably, surprises and setbacks will occur during the pre-launch phase of the project and you'll need extra capital to see it through. Request an amount that provides enough cushion in case of cost overruns. After all, most companies lose money during their first year of operation, and even well-run projects can find themselves over budget for reasons impossible to predict. Estimate the firm's burn rate (the amount of money spent each month on costs) and determine how long you can realistically afford to stay in business before you need to turn a profit.
Identify Sources of Small Business Funding
Some entrepreneurs are fortunate enough to have money that they can use to self-fund a new business effort. In such cases, these business owners can cover startup costs without asking for any money from outside sources.
For everyone else, financing will be required. And there are essentially two types of financing.
Equity financing is the act of selling a percentage of a company’s ownership to investors. This can be done at any stage of a business’s lifespan, from start-up to bankruptcy. If an investor pays $100,000 for 50% of your company, you are no longer the sole owner, but you do have $100,000 that you won’t need to pay back. There are two main types of equity financing.
Friends and Family
Countless firms are started by people who ask their family and friends to put up money to fund a business venture. Many times, the lenders are willing to provide the money with little or no interest. But be warned. There is an inherent risk of strained family relationships and loss of friendship if the business fails and the money is not repaid. Think long and hard about what it’d mean to be business partners with your parent, spouse, or best friend.
Entrepreneurs who do not have a network of family and friends willing to put up capital often look to venture capitalists who will put up the cash in exchange for a percentage of the company. It works essentially the same way as friends and family financing, but without the personal ties. The hit TV show Shark Tank has widened the understanding of this type of small business financing.
But once you have started your business it's very difficult to finance the business purely through selling shares. Most entrepreneurs will turn to other kinds of financing, specifically looking at business loans to make up the difference of what they need in order to keep their company running smoothly.
Debt Financing: Types of Small Business Loans
When it comes to getting funding for a small business, business loans and other alternative kinds of financing are both popular and accessible to many entrepreneurs. An added benefit of using a loan or alternative financing is that you keep full control of your business instead of giving up a piece of it to an outside investor. Today, there are any number of different types of loans available largely due to the internet making it easier for lenders to find entrepreneurs and vice versa.
Term Loans are traditional bank loans to small businesses in which the borrower requests an amount of money and then agrees to repay that amount of money with interest over the course of a specified period of time. In this way, securing a small business loan is similar to getting a mortgage to buy a house, right down to the fact that business lenders are typically repaid on a monthly basis.
In order to obtain a bank loan, borrowers need to meet certain criteria, which often include factors like having spent a certain amount of time in business, writing up a strong business plan, and having a personal credit score above the threshold set by underwriters. People with little or no credit repayment history often find it difficult to secure funding through a term loan because of these requirements.
SBA Loans are term loans that come certified by the United States Small Business Administration (SBA). The agency itself does not provide funding. Rather, the loan comes from an authorized lending partner - usually a bank -- at rates and terms determined by the lender. SBA loans differ from traditional small business term loans because the federal agency guarantees a portion of the loan, often up to 75 percent. That guarantee means that the lender has a far deceased risk of losing money should a borrower default on a loan. SBA guarantees also incentivize banks and other lenders to make capital available to entrepreneurs. Often, the interest rates charged are quite attractive and SBA loans are used by businesses at all stages of their growth.
The downside of SBA loans is that applications require extensive documentation, which slows the process and lengthens the amount of time it takes to finalize the deal. Decisions hinge upon the borrower's credit score, which is a reflection of his or her payment history. However, borrowers with a sufficient level of creditworthiness will find an SBA loan a really attractive option because the interest rates they offer are tough to beat with other financing options.
Business Credit Cards
Business credit cards are readily available and work just like a personal credit card, with credit limits that range from $3,000 to $20,000. The only difference is that they affect the credit history of your company as an entity instead of impacting yours personally. Often, they are easy to apply for and don't have stringent requirements, and many of the companies that issue business credit cards make an initial offer with a low annual percentage rate (APR) for a certain period of time.
However, after the introductory period has passed, the interest on credit card purchases can be quite high. Using credit cards to launch a business can mean high repayment costs if it takes a while to repay the debt. Further, if you need to borrow a large sum of money for purchases of property, building renovations, equipment purchases, and inventory, a credit card's borrowing limit may be too low for you to cover the full cost.
Business Line of Credit
A business line of credit is a form of small business financing in which an entrepreneur has cash available to draw upon whenever it's needed. It's like having a guarantee from the bank that money will be available for you to borrow if and when you need it. When needed, a business owner taps into the credit line and withdraws however much money is necessary. Interest is paid only on the amount of money that has been borrowed. Business owners like this type of small business financing because of its flexibility and because its interest rates tend to be much lower than the rates of business credit cards, which can approach 19 percent APR (annual percentage rate) or higher.
But while a business line of credit sounds like a perfect option for any business owner, the reality is that these are very difficult to acquire. Only certain types of businesses will be able to get approval for a line of credit, and they'll have to maintain excellent credit scores in order to keep the line of credit open.
Equipment financing is exactly what it sounds like. A business owner borrows money to buy a piece of equipment and pays it back over a certain period. With this type of funding, the equipment is put up as collateral. In case of default, the lender can take possession of the equipment and sell it to recoup the loss. That safety for the lender means equipment loans often come with attractive interest rates.
Accounts Receivable Financing
Accounts Receivable Financing is an option that established business owners use when they are caught in a cash crunch. If unanticipated costs or slow-paying customers are impacting cash flow, this type of financing can provide a quick infusion of capital. However, business owners should be aware that this is not a loan but an alternative kind of financing entirely. Essentially, you are selling your future earnings at a discounted price to the company that provides the funding up front. The flexibility that's offered by this kind of financing is great for businesses that need cash quickly to finance big projects today, and who have predictable income available in the future.
Merchant Cash Advance (MCA)
Merchant Cash Advance (MCA) is a similar form of small business financing to Accounts Receivable Financing. In fact, many people describe MCAs as a type of Accounts Receivable Financing. MCAs provide a lump sum of cash that is paid back by providing authorization for the funder to take a certain percent of your daily sales or credit card proceeds until the amount of the loan is repaid. In other words, borrowers are able to pay based on the company's sales. The amount of repayment during a period of time is related to the fortunes of the borrower. During good weeks, they pay more, during slower weeks, they pay less. This makes it a great option for businesses that are in need of flexibility in case of fluctuating sales volume.
The other unique trait for MCAs is that the repayment total is agreed upon from the beginning. For instance, if you need to borrow $10,000, the repayment amount might be $12,000, which is repaid as a percentage of credit card receipts after the money is withdrawn for the length of time it takes to repay the full agreed-upon amount.