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What Type of Small Business Financing Should I Get?


Question: What Type of Small Business Financing Should I Get?

Bank loans to small businesses are at a twelve-year low, according to a report in NBC Business. Small local businesses are just not getting bank loans for a variety of reasons. Whatever those reasons, businesses must look elsewhere for financing for startup and expansion.

What to consider before you obtain small business financing

If you are looking for a business loan, consider first what type of financing you really need. The rule of thumb is to match the financing source and time to the use of the funds and the length of time you will need the money. Some other considerations for type of financing are described in this article.

Debt or Equity
One of your first decisions should be whether you want to obtain money through equity (ownership) or debt (loans. If you are willing to give up a good deal of control, you might be able to get personal investors or partners or shareholders for your business. For example, you might be able to add one or more limited partners, who don't have a say in the day-to-day operations of the business, but who are part of the overall partnership and who share in the profits and losses. Read more about how a limited partnership might bring equity into your business.

If you are not willing to give up or share control, you can still get financing through debt sources, that is, through business loans or revolving credit. Another possible source of financing is leasing of equipment or vehicles.

Type of business
More high-tech companies may be able to get venture capital, but not the more typical "mom and pop" local businesses.

Type of assets
Businesses with high-value capital assets, like equipment, real estate, and vehicles, may be able to use the value of these assets to obtain financing for startup and operations with trade credit or vendor credit or by using these assets as collateral for a business loan. The value of the asset is liquidation value, which assumes that the asset must be sold in a bankruptcy or for minimum value, not at fair market value. The Small Business Administration has more information on the value of specific business assets when borrowing money for a business.

Lacking these assets, a startup business must look to other sources of assets for collateral, like finding someone to be a co-signer on your loan. This person must have personal or business assets that can be pledged to pay off the loan.

Amount of loan needed
If your business needs a lot of money, you must probably look at a mortgage or a long-term loan, but these are the types of loans that are most difficult to get from a bank. You might try a credit union as an alternative to bank financing for large sums.

You can also break a large loan into segments and finance each portion separately. For example, if you need money for expansion, you might be able to get a bank loan for the building changes (called leasehold improvements) and use trade credit for purchase of the equipment and furniture/fixtures you need.

Term of the loan
How long you need the funds an important factor in determining the type of financing. The general rule-of-thumb is to match the term with the type of financing - for long-term loans use long-term financing.

Alternative financing sources
Some other sources of business funding, from Rosemary Peavler, Guide to Business Finance include:

  • Merchant cash advances
  • Purchase order (invoice) financing
  • Peer-to-peer lending, which connects potential lenders and borrowers
  • Selling accounts receivable (factoring)
  • Financing with credit cards.
Obviously, these are expensive ways to raise money, but they can keep a business afloat for a short time.

Before you apply for financing
In any case, before you apply for a business loan, trade credit, or other financing, be sure to check that your personal credit is in excellent shape and that any business credit you have is solid. Read more about the Five C's of Credit for Business Loans.

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