Starting your own business can be exciting, but it can also be scary because of the money involved. If you lack sufficient funds to get your idea off the ground, you can explore financing options. By getting funding from a separate entity, you can preserve your internal finances and use the loan for operations.
1. SBA Loans
The U.S. Small Business Administration offers government business loans through banks and lenders. There are different types of SBA-backed loans, all of which are long-term and low-interest, perfect for entrepreneurs who are planning to jumpstart their business. Small business owners can also use the loan to expand, purchase real estate properties or equipment, and other operational requirements.
Commercial lenders and financial lenders are careful in approving loan applications from small business owners because they’re risky investments. Half of new businesses fail in the first five years. If the startup goes bankrupt, the borrower may not be able to pay back the loan.
SBA, on the other hand, maximizes access to affordable funding by offering a government loan guarantee of up to 85 percent. If you fail to meet the terms of the loan, SBA will pay the lender on your behalf. Because SBA absorbs most of the risk, lenders can work with borrowers they would have otherwise turned down. This means you have a higher chance for approval with SBA loans compared to bank loans.
To qualify for an SBA loan, you must meet the SBA definition of a small business, which has fewer than 150 employees and an annual revenue below $750,000 to $38.5 million depending on the industry. Your credit score must also meet the required level, as well as your equity and repayment ability.
2. Line of credit
A line of credit (LOC) is an arrangement between a customer and a bank or other financial institutions. The two parties agree on a credit limit, or the ceiling loan amount the customer can borrow.
You can secure your credit line with a collateral, which provide you with lower interest rate and higher credit limit. Collaterals aren’t mandatory but not promising any may lead to a higher interest rate.
An LOC agreement can be advantageous for small business owners because of its flexibility. Credit lines are revolving accounts, which means borrowers can spend, repay, and spend repeatedly; as long as they don’t exceed the maximum amount and make their payments on time. This allows business owners quick and easy access to funds when they need it.
You can apply for a higher credit limit than you need, just to have a cushion for emergencies. But you don’t have to spend it if it turns out you don’t need to. The interest is calculated only according to the amount you’ve spent and not on the entire credit line. Entrepreneurs can also adjust their payment amounts, depending on their revenues.
To qualify for a business line of credit, the bank or institution providing the LOC will assess your business’s market value, profitability, and exposure to risk.
A line of credit may seem appealing to small business owners due to its flexibility, but it also poses a number of possible pitfalls for the borrower. An open credit line may lead to overspending. Also, the penalties for not meeting the payments deadlines and exceeding the credit limit may be severe.
These are just two methods to acquire funding for your small business. Assess the needs, risk, and industry of your business, as well as your personal financial position to help you decide which financing method is more beneficial.