Want to know how to get funding for your business? Of course you do. However, many entrepreneurs are a little stumped by this question. Many small business owners don’t know where to begin their search or may feel overwhelmed by the number of options. Or, if they’re not confused, they might be intimidated – after all, applications for small business loans or grants are notoriously lengthy and jargon-filled. However, never fear – we’re here to break it down for you. If you want to know how to get funding for your business, read on.
How to get funding for your business in 5 steps
1. Ask yourself why you need a small business
The first and perhaps most important question you should ask yourself is why you are applying for small business funding. It’s the first thing every lender will ask you, so make sure you are armed with the answer. For instance, some small business owners need working capital to cover a range of everyday business costs; in contrast, some may need funding for a specific purchase, like a piece of equipment. As such, what you need the funding for will steer your choice of creditor and product. Therefore, it’s important to define what you need before you begin your search – it will narrow things down a lot.
Reasons you might need business funding
- Working capital. Working capital is the umbrella term for the day-to-day cost of running a business. This includes salaries, marketing, office supplies, or shipping costs.
- Cash flow cover. Cash flow is one of the top challenges for small business owners. For instance, if a client pays an invoice late, it can cause serious gaps in cash flow. To manage this issue, you might consider applying for an invoice financing product.
- Business growth. You might have identified an opportunity for expansion, but need some extra cash to make your vision a reality.
- Equipment financing. If you need funding for a specific business purchase like a vehicle, computers, or machinery, you should look into equipment loans or leasing.
- Debt refinancing. If some of your existing debt has become unaffordable, you might want to pay off said debt with a more affordable loan – a bit like a balance transfer on a credit card.
Sometimes, the options might not be so clear cut. For example, you might be looking to refinance existing debt while getting some extra funding for everyday expenses. However, there are plenty of lenders who work with businesses who need financing for various reasons – just make sure you have your story straight before you make your application.
2. Figure out what you can afford
Calculating the amount of financing you need is a delicate balance. Take out too much and you could end up with unaffordable debt; take out too little and you can wind up missing opportunities. However, there is a method of figuring out the right amount to borrow: calculating your Debt Service Coverage Ratio (DSCR). This is a calculation creditors use to figure out whether or not you can afford to pay back the loan – so spare your credit score the trauma of possible rejection and do it before you apply. To calculate your DSCR, take your average monthly net income and divide it by the monthly loan repayment, including interest. If the result is over 1, you have enough cash to cover your expenses and loan repayments. If it’s below 1, you need to rethink the amount you’re requesting.
3. Start browsing different products
The next step of how to get funding for your business is to start shopping around. This is the part that can be the most unwieldy, as now there are so many different options. However, our two previous steps will help you narrow down the search. To help you out a little more, below is a list of some of the different funding options you might want to explore.
A traditional bank loan tends to be the most affordable type of business funding. However, there is, of course, a catch. The application process is long and the qualification terms are strict. Usually, banks only deal in large loans (over $250K) and you need a glowing personal and business credit report. Furthermore, it’s also likely you’ll need the assets to collateralize the loan.
Certain loan programs are backed by the Small Business Administration, a government bureau that supports small business. Bear in mind the SBA doesn’t actually grant the loans – they guarantee finance provided by third parties. This means that the loan is less risky for the lender, which makes them more likely to approve an application. Although you still have to have a good credit score and no delinquent debt to the government, they are a good option for a range of business needs. For instance, their microloan program incentivizes lender to grant business loans of under $50,000. For information about government-backed programs, check out this article.
Business line of credit
A business line of credit is a good call if you’re looking for working capital. Functioning similarly to a business credit card, you only pay interest on the amount of money you borrow – and once you pay it back, you can borrow it all over again. However, you’ll need a good credit score and a decent track record to qualify.
We introduced invoice financing briefly above. These products are designed to plug holes in your cash flow, filling the gaps when a client pays an invoice late. How it works is that a creditor will advance you a portion of the value of the invoice. While you wait for the client to pay, the creditor charges interest on the amount they’ve retained. Once the client makes the payment, they release the remainder of the funds less the interest. The good news about these products is that they’re easier to qualify for than bank loans, as the invoice value acts as collateral.
This is another one we mentioned earlier. Equipment financing and leasing is a good option if you need to make a one-off purchase that you can’t afford to pay for up front. Typically, a lender will loan you the cash then you’ll pay it back in monthly installments, plus interest. Some lenders will also offer leases with lower rates. The perk of this type of funding is that it’s quite easy to qualify for, as the purchase acts as the collateral.
Merchant cash advances
Merchant cash advances (MCAs) have the least stringent qualification terms and fastest turn around times. How it works is that the creditor advances you the money, then takes a percentage of your future credit card sales as repayment. However, this flexibility comes with a price tag. You also might have to switch your payment processor to make the repayments.
4. Prepare your documentation
Once you’ve identified the product you want to apply for, it’s time to prepare your documents. This is another important stage in how to get funding for your business; you want to make sure everything is present and correct before making your application to ensure success. Generally speaking – and this isn’t rocket science – the more stringent the qualification terms, the more documents you’ll have to provide. As such, traditional bank loans require the most preparation, whereas an MCA application could take a matter of minutes. Either way, below is a list of things you’ll need to get ready. Bear in mind that each lender’s requirements will be different and the documentation you’ll need isn’t limited to this list.
Documentation you might need to apply for business funding
- Credit score. Every lender will check your credit score, as it indicates how reliable you are as a borrower. While a low score doesn’t necessarily always take you out of the game, it will usually mean you won’t be able to get the best value products. Remember, if your credit score is low, not all is lost. Check for errors with the major credit bureaus or select a credit-building product like those offered by credit unions or online lenders.
- Average cash flow. Lenders will want to check out your cash flow situation to make sure you can keep up with repayments. The larger the loan you seek, the more cash you’ll need to prove you have on hand. Therefore, you need to evidence your average monthly bank balance, usually with about two years’ worth of statements.
- Income statement. Your income statement will show the source of your business revenue and expenses, and how your profits fluctuate. Again, creditors are likely to be interested in the past two years.
- Balance sheet. Similarly to the above requirements, a balance sheet is an indicator of your business performance. Your balance sheet will show how much you have in assets and how much debt you already owe.
- Time in business. This is a simple one – many lenders will want to know how long you’ve been operating. This will vary from lender to lender, but it’s basically an indicator of the viability of your business.
- Tax returns. Lastly, it’s very likely the lender will want to see your personal and business tax returns to verify the rest of your financial statements – so make sure you have them to hand.
5. Application time
Finally, we’ve reached the crescendo of how to get funding for your business: submitting your application. We suggest you don’t make more than one or two applications, as too many hard credit pulls can damage your score. Once you submit your application – either online or on paper – the lender will let you know if you are approved. Depending on the type of product, this timeline can vary a lot. However, once they’ve made their decision, they’ll review your documentation and underwrite the loan. The final stage is signing on the dotted line – so make sure you read all the small print. Before signing up, ensure you are confident you can:
- Pay on time and with the required frequency.
- That this is the lowest rate you can get.
- That there are no hidden costs or fees.
- That you have compared and contrasted all available products.
- That this will contribute to business growth.
And that concludes our guide to how to get funding for your business. If the answer to all these questions is ‘yes’ go ahead – it’s time to kick-start your business growth!