What are the Sources of Small Business Finance?

Learn about different sources of finance available for small businesses including bank loans credit cards lines of credit alternative financial companies accounts receivable purchase orders venture capital private equity etc.

What are the Sources of Small Business Finance?

Contributing your own money to your business is the simplest way to finance it. You can take advantage of your savings, use a home equity line of credit, or sell or borrow from a personal asset, such as stocks, bonds, mutual funds or real estate. Around 80 percent of the estimated 27.5 million American small businesses, defined as those with fewer than 500 employees, use some type of credit to help finance their operations. This funding includes bank loans, credit cards and lines of credit.

During the banking crisis, many of the country's 7,800 credit unions accumulated billions of dollars thanks to their member savings and interest on mortgage and auto loans. Approximately 2,000 of them are already providing commercial loans to their members, and others are increasing their lending capacity for small businesses. Credit unions are non-profit organizations and are generally able to offer better terms to their borrowers than commercial banks. Their membership rules have also become more relaxed over time.

Hundreds of alternative financial companies offer short-term cash loans to small businesses. However, these loans often come with high fees and interest rates and are poorly regulated with low standards. Small business owners should be very careful before signing a contract with one of these groups. Another method of obtaining funding for a small business is to use accounts receivable, that is, customer credit accounts as collateral for a short-term loan from a bank, commercial financial firm, or other financial institution.

The small business owner is still responsible for debt collection, while the lender generally anticipates 75 to 80 percent of the value of all receivables it deems acceptable. If the small business doesn't repay the loan, the lender can take care of the business's receivables and collect the debts themselves. Interest rates on receivables can be high, more than 36 percent per annum. Financing purchase orders is similar to the practice of factoring, but in this case, a lender acquires a company's purchase order from a buyer who undertakes to buy the product the small business sells. The lender could then pay the costs of fulfilling the order, including the manufacturing process and shipping.

Once the buyer has paid the lender, they will keep their share and then hand over the rest of the money to the small business owner. Again, interest rates for this type of financing can be high, ranging from 1 to 5 percent per month. In exchange for a fee, a few companies will help a small business owner invest part or all of a 401 (k) or other individual retirement account (IRA) in the company, converting retirement savings into working capital. This type of financing does not involve the payment of debts or interest but it exhausts a business owner's retirement account and puts it at risk at the same time. It is only recommended for business owners who are sure that their businesses are strong and that their money will grow safely. The bank required several of its 3.5 million small business customers to immediately settle line of credit balances.

If they couldn't pay in full, they were offered new payment plans with significantly higher interest rates. The first thing to keep in mind is that venture capital is not necessarily for all entrepreneurs. From the start, you should keep in mind that venture capitalists are looking for technology-driven companies and companies with high growth potential in sectors such as information technology, communications and biotechnology. BDC has a venture capital team that supports cutting-edge companies strategically positioned in a promising market. Like most venture capital firms, it participates in startups with high growth potential and prefers to focus on major interventions when a company needs a large amount of funding to establish itself in its market.

Angels tend to keep a low profile. To get to know them, you should contact specialized associations or search websites about angels. You can check their member directory for ideas on who to contact in your region. Business incubators (or accelerators) generally focus on the high-tech sector by supporting startups at various stages of development. However, there are also local economic development incubators which focus on areas such as job creation, revitalization and housing and exchange services. MaRS, an innovation center in Toronto has a selective list of business incubators in Canada plus links to other resources on its website.

There can be strong competition and criteria for prizes are usually strict. In general most grants require you to match what you receive and this amount varies greatly depending on the grantor. BDC offers seed funding to entrepreneurs in the start-up phase or in the first 12 months of sales. You can also postpone principal payments for up to 12 months. Banks have a special department dedicated to lending to small businesses. To get a loan from a bank companies must meet its minimum criteria which vary from bank to bank regarding revenue potential annual turnover credit ratings etc.

Banks offer many types of loans such as working capital loans term loans loans against properties etc. Companies can choose according type loan according their requirements. Each country has certain banks or institutions dedicated only lending small businesses an example such institute India SIDBI United States SBA main purpose these institutions lend money small businesses unable obtain financing reasonable terms through normal lending channels these entities usually grant money only loans. Private equity type share capital not listed any stock exchange these firms raise funds investors then invests funds buy capital promising startups (26% small companies) drawback this type funding private equity firms will...