There is a traditional route people would follow when building a small business from the ground up. You come up with a business plan, figure out your USP and marketing, and then apply for financing. Years ago, just about everyone would go to the bank for a loan. However, today there are many more options, with private lenders as well as modern innovations such as peer-to-peer lending.
Of course, not every business needs financing from an external source. Some businesses do not require much funding to get off the ground. If you are starting a house-sitting business, for example, you are essentially just selling your time. If you employ others, you can pay them a portion of the profits. You may need to pay to set up a website, but should not have to take out a loan or get investment to do so.
However, certain businesses need a lot of financing that individuals just don’t have. This is especially true in the construction industry. Construction companies need heavy equipment that costs hundreds of thousands of dollars. They may also choose to do projects to build up their own business that require access to building materials.
The field of business financing may seem complicated to beginners, but so many companies have gone through the process before that it is now fairly routine. There are decisions you will need to make, like whether to go to a bank or to get a business loan from a Lender. The latter is becoming more popular, and there are reasons to avoid banks if you can.
Furthermore, the reality is that it is best for many companies to avoid financing through a loan at all. Let’s go into the reasons for this before delving further into the types of financing available.
Why you should avoid financing if possible
Many entrepreneurs who have the capital to get a business started choose financing anyway. This way, they have money in the bank for any unexpected hiccups. They will also be able to last longer if they do not hit the income projected on time.
However, this is not the most financially sound way to go about it. To start with, any interest your money is growing while in the bank is going to be significantly less than the interest you are paying on the business loan. You also stand to lose the property you have purchased with the loan if you have to default.
It also means you will likely end up in debt if your business fails and the property you have purchased does not cover what you owe. At this point, you have probably already eaten into your capital, and may struggle to get out of the red again.
This sounds drastic, but it is the worst case scenario. Many small businesses get financing and are successful, or are able to take it on the chin if things go wrong. But if you are in a position to use your own finances, you should seriously consider it over a loan.
Of course, a loan is not the only type of financing available to small businesses.
Equity Investment vs Lending
Many modern businesses are financed by so-called “angel” investors. These are venture capital companies or, sometimes, wealthy individuals who have capital to spare and believe in the business plan. They put their own money at risk for equity in the business. In other words, they will take a share of the profits.
Equity investment is a very attractive proposition. Aside from the fact that it feels good to have someone show belief in your idea by investing significant funds, it also means that you won’t end up in debt if your business fails. In fact, the investor will take most of the blow. Good investors are generally prepared for setbacks or failures, and will have various other investments that succeed even if yours does not.
The most obvious downside of equity investment is that you do not get all of the profits. Depending on your agreement, you share the profits and may therefore take longer to actually hit your goals, even when your business is succeeding.
Furthermore, the investor gets some control of your business. This may not be part of the deal, but they can threaten to stop funding your business if you do not do things their way. Also, if a bigger business offers to buy your company, you may have to say no even if you like their offer.
When you lend money to finance your small business, you may be in debt, but any profits you make are entirely yours. You have full control over how you run your business. Offers to purchase go straight to you, and you can make decisions for your own financial future and career.
That said, the possibility of no longer being able to pay off your loan might lead you to be extra cautious. The control you have by being the sole owner is offset by the risk you face if it does not work out.
Dealing with business debt
The key to successful business loans is a specific mindset. You need to be able to see the risks for what they are and understand that without risk there is no reward. You need to be comfortable with sitting in the red for a while, and maybe even choosing to run your business from a position of debt.
If you are ready to get a business loan, what types of small business loans are available?
Banks vs Lenders
Traditionally, small business owners went to their banks to get loans. However, these days, people have begun to consider banks to be dinosaurs. They do not innovate and create products for businesses in the twenty-first century. Private lenders are more likely to have loans that suit your particular needs as a modern startup.
These days, it is the private lenders that get big loans from the banks. They benefit from the simplicity of big bank loans, and use the finance to provide more nuanced options for smaller lenders.
There are a number of different types of loans for small businesses from private lenders. If you are purchasing property or expensive equipment, a secured loan will come with a lower interest rate. If you do not have asset requirements, an unsecured loan will come with a higher interest rate, but will be better suited to your business needs.
In times of economic crisis, like the one caused by COVID-19, the government will make funds available both to banks and private lenders so that they can continue to fund small businesses. We have seen this happen in 2020 as Australia has gone in and out of recession.
This serves as a poignant indication of how much of the economy relies on lending. While all business owners would ideally like to finance entirely with their own capital, it remains unrealistic for most and loan products are only getting better.
Summary
Financing a small business is a confusing endeavour for first-time business owners. However, it has been done by millions since the dawn of banking, and is still how most businesses get themselves off the ground. There are plenty of protocols in place, and more products than ever from private lenders.