At one point or another, most business owners have to think about how they will finance their operations. Whether you borrow money, draw from your own savings or choose another option, it's important to choose the one that makes the most sense for you.
But how are other entrepreneurs faring on the various paths to business financing? Here's what is happening in three of the biggest areas of funding right now.
Funding your business out of your own pocket — commonly known as bootstrapping — is the simplest, but potentially most difficult, financing route. On the one hand, you are in total control of your finances: You don't have to make any payments to lenders or share equity with investors. On the other hand, you're on the hook for every penny you sink into the company, and if it fails, your personal funds are going down with it.
That doesn't stop the majority of U.S. entrepreneurs from exploring bootstrapping as an option. A recent study by invoice factoring company BlueVine found that 75 percent of American small business owners rely on personal finances as their primary source of business funding, and 83 percent overall have put their own money into their companies.
Ed Castano, vice president of marketing at BlueVine, said this trend shows the resourcefulness of today's entrepreneurs, who often turn to self-funding because they either don't qualify for a traditional business loan or aren't aware of all the financing options available to them. However, the study found that 4 of 5 small business owners have experienced a gap in cash flow, and bootstrapping may increase your odds of falling short financially.
"We see entrepreneurs end up in a position where growth and revenue is strong, but because of long payment cycles, they are short on cash to meet payroll, purchase supplies or acquire inventory," Castano said. "Understanding your options, whether it be a bank line of credit, invoice financing, purchase order financing, or something else, can be the difference between expansion, stagnation or layoffs for a small business."
Learn more about bootstrapping your business here.
In the last several years, the business finance world has exploded with "alternative lenders," companies that provide quicker, smaller loans through an online application and transfer process. Depending on your credit score, you can be approved for a loan in a matter of minutes and have your money in just a day or two.
"As you can see from OnDeck's IPO, Lending Club's entrance into small business lending, and a burgeoning number of new entrants, small business owners have an unprecedented number of lenders to choose," said Cindy Yang, a small business expert at NerdWallet, which provides information, reviews and comparison tools for finance products. "[With alternative lenders] you might have more flexibility in the loan — longer repayment terms, lower origination fees, etc."
While having all these options can be great for businesses that may not qualify for a traditional bank loan, it also means you'll need to be much more diligent about researching potential lenders and their reputations. Sabrina Parsons, CEO of Palo Alto Software, which created business management software LivePlan, said that although online lenders will make a lot of promises about their funds, some are just "sharks" out to take advantage of small business owners.
"These sharks will charge business owners to 'qualify' for a loan and to have access to their lenders," Parsons said. "[Also, some alternative] loans can come at a very high interest rate, and business owners need to understand the implications of these types of loans."
Learn more about alternative small business loans in Business News Daily's best lender picks list.
Traditional bank loans
The notoriously high rejection rate of bank business loans combined with the proliferation of online lenders has made traditional business lending seem like it's not even worth the time and effort. But plenty of small business owners still turn to local and national banks, as well as the Small Business Administration (SBA), to help them finance their operations.
"There's still a lingering perception out there that banks aren't lending, but that's not true," said Jay DesMarteau, head of small business banking at TD Bank. "Credit is available, and any small business can be a loan candidate."
Because of the recent Federal Reserve interest rate increase, DesMarteau said some small business owners who were on the fence about refinancing their debt or applying for credit will likely make a move quickly to lock in the lower rate while they still can. He also noted that TD has noticed an uptick in applications and deals done through its SBA lending program.
"This can be a good option for small businesses because some of the credit and underwriting needs might be different than a traditional bank loan, allowing more businesses to receive the financing they need," DesMarteau said. "Last year, TD Bank nearly doubled its lending in key areas like New York and Florida."
Learn more about how to get a small business loan here.
Venture capitalists and angel investors have helped tens of thousands of startups get off the ground, but it's not always easy to stand up in front of a team of investors and tell them why they should give you their money. It requires a well-written business plan, solid financial projections and a whole lot of confidence.
Christopher Hale, founder and CEO of kountable, a platform that connects entrepreneurs in developing countries with investors based on a "social capital" score, said that what investors are really looking for is how close a business gets to the underlying economic activity of a community. To ascertain this, investors will look at some of the same things lenders do — cash flow, market opportunities, the founding team's experience, etc. Entrepreneurs in the modern world have one more trick up their sleeve: their digital footprint.
While your online presence is certainly not the only factor in an investment decision, an active website and social media presence can give investors an inside look at what your business is doing, and create transparency about the economic opportunities of your venture.
Hale noted that kountable's social capital measurement, or "K score," takes online activity into account when evaluating entrepreneurs.
"We gather a number of different data points, [but] we're not looking at the traditional definition of credit worthiness," he told Business News Daily. "The K score measures performance capability, [which] is fairly easy to identify in one's digital footprint."
The use of nontraditional criteria such as social media activity is beginning to take hold in the lending industry as well. Experian DataLabs has been conducting research on the correlation between a business's social media use and its credit risk, which could help financial institutions get a more well-rounded view of an applicant.
Learn more about what today's investors are looking for here.
In an age when new Kickstarter, GoFundMe and Indiegogo campaigns emerge every day, crowdfunding is quickly becoming a go-to option for businesses that want to raise money without the pressure of formally pitching investors. Success stories of entrepreneurs who raised tens of thousands — even hundreds of thousands — of dollars in just a few short weeks seem to be a dime a dozen, but is everyone really jumping on board the crowdfunding train?
According to a March 2015 survey by online small business community Manta, only 2 percent of the nearly 1,300 business owners polled said they have ever used a crowdfunding platform. This may be because many entrepreneurs are still uncertain about alternative financing options like crowdfunding: 30 percent of respondents said they are unsure of the risks, 20 percent don't understand the technology behind them, and 14 percent simply don't trust them. Manta CEO John Swanciger speculated that business owners' lack of awareness and misconceptions about their finance options could be to blame.
"Small business owners have more diverse options today than ever before when it comes to funding their business," Swanciger said in a press release. "However, we're seeing a gap between what's available and the perception among small businesses that the lending environment has not improved."
But attitudes may shift among small business owners as more of them come to understand Title IIIand Title IV (Regulation A+) of the Jumpstart Our Business Startups (JOBS) Act, which govern rules about direct public offerings and equity crowdfunding. These pieces of legislation were just passed in 2015, so any resulting trends have yet to be seen.
Learn more about current crowdfunding trends and tips here.
Entrepreneurs should note that, although the above-named methods of financing are the most common, they are certainly not the only ones. Visit this Business News Daily guide for a full list of alternative ways to fund your startup.
Tips for financial success
Whether you're financing a new business or just looking to increase your cash flow in 2016, here's what our expert sources had to say about boosting your financial success.
Think through your costs and cash flow. "Don't underestimate startup costs. Don't budget for a rosy scenario, and always build a cushion. [Many] businesses don't budget enough, which is why most small businesses fail within the first two years. If possible, start a business that has low startup costs and strong, immediate cash flow." – Ed Castano
Develop a good relationship with your banker. "A good banker can add real value to a business [by] reviewing strategy, recommending debt structure, reviewing other banking products to help with cash flow, cash management, and working with their CPA and attorney. A business working solely with an online lender will never have a value-added relationship with a banker." – Robert Polito, Jr., senior vice president and director of government guaranteed lending (SBA) at Webster Bank
Clean up your finances before applying for a loan. "The huge spike in interest rates and low borrower grades in December [according to NerdWallet's analysis of Lending Club data] means that small businesses who might be in bad shape are looking for funding. Because interest rates are so high, that could put them in an even worse position in the future. Making sure your finances are sustainable is the key to long-term success." – Cindy Yang
Understand your options. "When evaluating financing offers from different sources, small business owners need to explore the options available and understand all of the loan terms offered to them. In addition to the interest rate, does the loan carry fees, prepayment penalties, interest only payments or other conditions? These are all important considerations to make sure you're getting the best deal." – Jay DesMarteau