Small business financing (also referred to as startup financing or franchise financing) refers to the means by which an aspiring or current business owner obtains money to start a new small business, purchase an existing small business or bring money into an existing small business to finance current or future business activity. There are many ways to finance a new or existing business, each of which features its own benefits and limitations. In the wake of the recent financial crisis, the availability of traditional types of small business financing dramatically decreased. At the same time, alternative types of small business financing have emerged. In this context, it is instructive to divide the types of small business financing into the two broad categories of traditional and alternative small business financing options.
Traditional Small Business Financing Options
There have traditionally been two options available to aspiring or existing entrepreneurs looking to finance their small business or franchise: borrow funds (debt financing) or sell ownership interests in exchange for capital (equity financing).
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Debt Financing
The principal advantages of borrowing funds to finance a new or existing small business are typically that the lender will not have any say in how the business is managed and will not be entitled to any of the profits that the business generates. The disadvantages are the payments may be especially burdensome for businesses that are new or expanding.
The sources of debt financing may include conventional lenders (banks, credit unions, etc.), friends and family, Small Business Administration (SBA) loans, technology based lenders, microlenders, home equity loans and personal credit cards. Small business owners in the US borrow, on average, $23,000 from friends and family to start their business.
The duration of a business loan is variable and could range from 1 week to 5 years or more, and speed of access to funds will depend on the lender's internal processes. Private lenders are swift in turnaround times and can in many cases settle funds on the same day as the application, whereas traditional big banks can take weeks or months.
Equity Financing
The principal practical advantage of selling an ownership interest to finance a new or existing small business is that the business may use the equity investment to run the business rather than making potentially burdensome loan payments. In addition, the business and the business owner(s) will typically not have to repay the investors in the event that the business loses money or ultimately fails. The disadvantages of equity financing include the following:
The sources of equity financing may include friends and family, angel investors, and venture capitalists.
Alternative Small Business Financing Options
As access and availability to traditional small business financing has declined, several forms of alternative small business financing options have emerged. While most of the options are simply adding new sources for debt and equity financing, the ability to use retirement funds to finance a new or existing business offers a new type of small business financing.
Small Business Grant Programs, Including those Designated for Women and Minorities, Include:
- The Eileen Fisher Women-Owned Business Grant Program: Five grants are awarded annually. The businesses must be 100 percent women-owned and have founding principles of social consciousness, sustainability and innovation, plus be ready to move to the next phase of development. In 2014, the program awarded $125,000 in grants.
- Huggies Brand -- Mom Inspired Grants: The grant awards up to $15,000 to advance the development of innovative products inspired by the joys of motherhood. The awardees also receive resources to further develop their products and startup businesses.
- FedEx Think Bigger -- Small Business Grant Program: Applicants are encouraged to share their visions to receive a portion of the $75,000 awarded in grants. Part of the judging involves the general public voting for the finalists, so participants may promote their businesses while garnering votes.
- ezDinero Avenues of Opportunity Latino Small Business Grant: $1000 grant for Latino entrepreneurs. The funds are earmarked to assist individuals who are either launching a new enterprise, or those who need maintenance assistance for future growth.
- Idea Café Small Business Grant: The Idea Café is a free gateway that hosts different grants on its site. Its current grant is the 16th Small Business Cash Grant, which awards one $1,000 grand prize to a business with the most innovative idea.
- InnovateHER: 2015 Innovating for Women Business Challenge: This business challenge is sponsored by the Small Business Administration (SBA) Office of Women's Business Ownership. The challenge awards three winners $30,000 in prize money for businesses that have an impact on the lives of women. However, be aware of the recent fraud news around the SBA.
- Chase Google -- Mission Main Street Project: Chase and Google have partnered to award $3 million in grants. In 2014, recipients were awarded $150,000 to help take their businesses to the next level. Recipients also received a trip to Google headquarters, a Google Chromebook laptop and a $2,000 coupon toward a market research study with Google Consumer Surveys.
- Small Business Innovation Research (SBIR): Eleven different federal agencies participate in this awards-based program, which incentivizes and enables small businesses to explore their technological potential.
- Small Business Technology Transfer Program (STTR): The STTR program reserves a specific percentage of federal research and development funding to provide funding opportunities in research and development.
- Women Veteran Entrepreneur Corp (WVEC) Small Business Competition: This competition, organized by Capitol One and Count Me In for Women's Economic Independence, allows participants to present two-minute pitches for a chance to participate in a nine-month business accelerator program.
- Wal-Mart Women's Economic Empowerment Initiative (WEE): As part of a huge Wal-Mart initiative, sourcing opportunities for U.S. and international companies will increase to $40 billion over five years.
- Zions Bank -- Smart Women Smart Money: This Utah-based bank's grant annually awards $3,000 across six different categories, including business.
Rollover Retirement Funds to Start or Finance a Business
A lesser known but well-established means for entrepreneurs to finance a new or existing business is to rollover their 401k, IRA or other retirement funds into their franchise or other business venture. This financing option is often called "Rollover as business startup" or "ROBS" financing. This isn't a loan: instead, the business owner forms a C Corporation, which sponsors a profit sharing retirement plan. From there, the business owner uses that company retirement plan to buy shares of his own company, thus contributing to the company's finances.
This small business financing option allows the business owner to obtain the benefits of debt and equity financing while avoiding the disadvantages such as burdensome debt payments. More than 10,000 entrepreneurs have used their retirement funds to finance their start-up businesses.
The IRS has clearly stated that the use of retirement funds to finance a small business is not "per se" non-compliant. ROBS financing is complicated, however, and the IRS has developed a set of guidelines for ROBS financing. As such it is essential to employ experienced professionals to assist with this small business financing strategy.
New Sources of Debt and Equity Financing
In the wake of the decline of traditional small business financing, new sources of debt and equity financing have increased including Crowdfunding and Peer-to-peer lending.
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