Small businesses are the backbone of the American economy as they account for more than half of all private sector jobs in the United States. And while there are many ways to finance a small business, not all of them are created equal.
In this article, you'll learn about the most common types of small business financing and how to go about securing the best option for your company. You'll also learn about the pros and cons of each type of financing so that you can make an informed decision about which option is right for you.
Small Business Loans
Small business loans are the most common form of financing for small businesses that can be used for a variety of purposes, such as working capital, equipment purchases, or expansion. Small business loans can come from a variety of sources, including banks, credit unions, online lenders, and the Small Business Administration (SBA).
The Pros: Small business loans can be a great way to finance your business as they typically have lower interest rates than other financing options, such as credit cards. They also tend to have longer repayment terms, which can give you some breathing room when it comes to repaying the loan.
The Cons: The biggest downside to small business loans is that they can be difficult to qualify for, especially if you have bad credit. And even if you do qualify, the approval process can take weeks or even months.
Buying Securities aka Securitization
Securitization is the process of pooling together a group of assets and selling them off as security. This is typically done to raise capital or to transfer risk but to get permitted securitization financing, there are a few compliance boxes that must be ticked. The assets in question must generate a regular stream of cash flow, they must be easily valued and there should be a low probability that they will all default at the same time.
The Pros: The main advantage of securitization is that it allows companies to raise capital without taking on debt. This can be especially helpful for companies that are unable to qualify for traditional loans. Additionally, securitization can help to transfer risk away from the company and onto the investors.
The Cons: One of the biggest disadvantages of securitization is that it can be a complex and time-consuming process. Additionally, there is always the risk that the assets in question will not perform as well as expected, which could lead to losses for the investors.
Another way to finance your small business is by selling equity which means that you sell a portion of your business in exchange for funding. The most common way to do this is through venture capital firms, although there are other options, such as angel investors or crowdfunding.
The Pros: One of the main advantages of selling equity is that you do not have to repay the funding that you receive. Additionally, selling equity can help to dilute the ownership of your company, which can make it easier to raise additional funding in the future.
The Cons: One of the biggest disadvantages of selling equity is that you will give up a portion of control over your company. Additionally, if your company is not successful, you could end up losing all of your equity.
Grants are another way to finance your small business and they are typically awarded by government agencies or foundations. Grants can be used for a variety of purposes, such as research and development, marketing, or expansion.
The Pros: One of the main advantages of grant financing is that you do not have to repay the funding that you receive. Grants can also be a great way to get your business off the ground if you are unable to secure other forms of financing.
The Cons: The biggest downside of grant financing is that it can be very competitive and there is no guarantee that you will receive funding. Additionally, grant funds typically have to be used for specific purposes and they often come with strict reporting requirements.
Finally, crowdfunding is a relatively new way to finance your small business and it involves raising money from a large group of people, typically through the internet.
For instance, if you want to launch a new product, you can create a campaign on a crowdfunding website, such as Kickstarter, and offer rewards to people who contribute money to your project.
The Pros: One of the main advantages of crowdfunding is that it can be a great way to get your business off the ground if you are unable to secure other forms of financing. Additionally, crowdfunding can help to build buzz and excitement around your company.
The Cons: The biggest downside to crowdfunding is that it can be very time-consuming and you may not raise as much money as you had hoped.
There are a variety of different ways to finance your small business and each has its pros and cons. The six most common types of small business financing are selling equity, securitization, grants, crowdfunding, debt financing, and venture capital.
By understanding the basics of each type of financing, you can make an informed decision about which option is best for your company.