One of the most crucial challenges for a startup is financing. There are many options available, both traditional and innovative. You must understand all funding options before selecting one.
This article will discuss different options for financing, including traditional and non-traditional methods, to help you make the best choice. What must you know before choosing a financing option that works for you?
How To Select the Best Financing Option for Your Startup
Start by understanding what your new business needs. Startups often use venture capital or business loans to finance these common challenges:
- Staffing expenses. This includes salaries for a complete team, including operations and sales departments, paid hiring firms, and training resources for your teams.
- Product development. This includes your original product plus related development for expanding your lines.
- Marketing efforts. This goes towards promotional efforts, including advertising fees and marketing materials.
There are several options, and all of them have their own advantages and drawbacks.
Venture Capital
Venture capital is the first type. Investors put corporate funding into launching startups in exchange for a stake in the business. New companies often benefit from the expertise, knowledge, and connections of the investor. In addition to providing funding, entrepreneurs get an experienced partner who can help the firm grow while avoiding costly and damaging errors.
Venture capitalists help you navigate the creation of your new product or service. For example, they may advise you to reposition your target audience or alter your product development to better fit the need.
The downside is that you’ll need to give up some managerial control and agree to decisions you may not like. You may also need to sign over a significant share of the profits. To attract venture capital opportunities, you must prove the potential success of your startup.
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Business Loans
If venture capital doesn’t appeal to you, a business loan is your next option. There are two types. A secured loan requires significant business assets as collateral to cover it. Since most startups won’t have that much funding, you may want to consider an unsecured business loan. Because you don’t need capital, the approval process is faster than a secured loan.
However, you’ll need a proven track record in your business to qualify alongside a good credit score. Another drawback is that some lenders require a personal guarantee. If the loan defaults, you must pay it back with your own funds. This could harm your credit score and put your personal assets at risk.
Unsecured loans also have higher interest rates than secured ones, as they pose a higher risk to the lender. To qualify, provide business income, credit history, and your business plan. You’ll also need to show how long you’ve been in business.
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Opening a Line of Credit
Your next option is to open a line of credit. Banks and credit unions can offer you a set amount of funds to borrow from. You pay interest only on the borrowed amount, so the wisest course of action is to take out only what you need.
Your lender will require several pieces of information before approving a line of credit: what it’s for, income, your debt-to-income ratio, current banking relationships, credit score and history, and collateral. Once approved, they’ll give you a set limit that you can borrow against. Because they have great flexibility and lower interest and fees than credit cards, these can be a good option for entrepreneurs.
Like a loan, lines of credit are either secured, which carry lower interest rates, or unsecured, which rely on improved credit ratings.
Borrowing Against Your Investment Portfolio
If you have an investment portfolio, you can use it as collateral to take out a loan against your existing investment assets. Weigh the pros and cons of a securities-based loan. Also called non-purpose loans, these grant you extensive freedom in how you use the funds for your business.
These loans are a good option if you don’t have ideal credit and don’t want to sell your assets. The process is easy, allowing quick access to funding. You may even get lower interest rates than other types of loans. Securities-based loans can range from $50,000 to $5,000,000, depending on what amount the lender approves.
However, these loans do have risks. If the value of your investments drops below the limit that your lender sets, you will need to either pay down the debt or put up additional securities. And if you cannot pay back the loan, you can lose your investment assets.
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Additional Business Funding Resources
There are other non-traditional sources of funding that may be available to you. For example, angel investing is similar to venture capital, except the investor uses personal funds. Another option is crowdfunding, where you ask people to donate to invest in your idea or business. Both carry higher risk than traditional options. However, there is one more option.
If you qualify as a disadvantaged startup owner, you may be able to find and apply for minority business loans. In 2021, Census Bureau data showed that white people own more than 85% of businesses with employees. Of those, 63% are owned by men. The following organizations can help alleviate these disparities for minority and other disadvantaged business owners:
- The Business Center for New Americans offers business loans to refugees and immigrants.
- The Small Business Administration (SBA) offers 7(a) loans that feature low-interest and accessible payment terms.
- The SBA 8(a) program for government contracting offers 5% of government contracts to disadvantaged U.S. citizens who own 51% or more of a business.
- SBA microloans, which are not limited to minorities, provide small loan amounts with better interest rates than credit cards.
- The African American Loan Fund provides loans up to $250,000 with 10% interest to qualified applicants, who receive financial and technical advice and support.
Search Grants.org to find more programs that serve disadvantaged groups.
Funding a startup takes innovation, ingenuity, and the right resources. There are several traditional or non-traditional methods and resources you can investigate to get the funding you need, depending on your worth and tolerance for risk. Do your due diligence to make the right choice to successfully support your fledgling business.
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