Small business owners face long odds – about 33% will fail in the first two years. Look out 5 years and around 50% will shut down. By far, the most prominent reason businesses fail is that they run out of money. In this article, we will discuss nine different strategies for small businesses to consider when looking for financing.
In my own experience, many of my clients are constantly chasing financing. Despite what you may read, small business financing is hard to obtain. Owners must be creative, looking under many rocks to find affordable financing.
What are the Challenges to Limited Access to Capital
Lack of Funds to Grow Business
As a business grows, opportunities will present themselves. A manufacturing client of mine recently had an opportunity to launch their product in a nationwide grocery chain. Most entrepreneurs would be thrilled with the chance to launch their product across 1100 locations. My client was thrilled, however, we began to realize how “costly” this growth would be.
As the initial discussions took place, we got a general idea of the product we would need to produce to satisfy this rollout. As a small manufacturer, capacity was somewhat limited. This meant the product would need to be produced before receiving the initial PO. Once the product was shipped, the standard payment terms were 90 days. As a result, we had to finance inventory in some cases for up to 6 months.
Additionally, there needed to be a marketing plan associated with the rollout. In many national grocery chain rollouts, thousands of dollars are associated with each rollout location. Costs often include discounts and coupons, in-store marketing, local advertising, and potential sponsorships. All of these costs were well before any revenue from the rollout would start to be realized.
As you can probably see, there was a six-figure capital requirement months before the rollout.
Some may suggest that this business just obtain some short-term financing. Like most small businesses in growth mode, their income statement did not show substantial historical profits. They had re-invested their profits in their business. Many financing options charged interest rates above 16%, which would drastically reduce the profit margin of this deal.
This is the dilemma that many small businesses find themselves in. Whether it be inventory, marketing, employees, or equipment, many entrepreneurs are challenged to find capital with financial statements that are less than attractive to traditional financing sources.
Lack of Financial Knowledge
Many owners lack confidence in the financial side of their business. They may come from a background in sales or operations. As a result, when talking with a bank or potential investor, they don’t believe they have the know-how to articulate the positives of their business.
As a result, many owners turn away from resources they mistaking don’t believe their business can obtain financing. Part of this “game” that entrepreneurs must play is presenting their current financial situation in a light that shows the upcoming growth and opportunities ahead.
Unclear Process
Let’s face it –obtaining capital or financing is akin to the wild west. There is no process. When you buy a house, 90% of us go the standard route and work with a mortgage professional. The process is well-defined (and regulated) and provides guardrails for the homeowner.
However, in business financing, there is no process. Depending on your route, the requirements, who to talk to, and which avenues to approach are drastically different. This can be intimidating for those that haven’t navigated. Some entrepreneurs don’t know where to start.
Poor Financials
In almost all cases, traditional financing methods require a review of the financial statements. As a CFO for several small businesses, I know that financials are often fairly “ugly” during the start-up phase. When a business is starting, costs are often more than revenue. Further, as they grow, profits must be reinvested and outlays for employees or equipment often are required before revenue.
Banks are happy to talk with businesses with six-figure bottom lines and equipment on their balance sheet that can be collateralized. However, this is not true for most small businesses.
Nine Ways to Overcome the Challenges of Limited Access to Capital
Before diving into different ways for a small business to access capital, let me note the value of an outsourced CFO. Most CFOs have had to navigate the various roads laid out below. They are also comfortable with having to craft a story or narrative that is needed.
If you are having issues raising funds, consider working with an outsourced CFO, even on a project basis. The time savings you’ll see and the knowledge they can bring represent significant value to your business.
Method 1: Bank Loans
The preferred method by far to raise funds is with a business loan from a bank. I often have my clients start with their bank, especially if they have a relationship with their banker (which is also why I prefer local banks). These funds don’t take equity in your business and are often at the lowest interest rates. However, is a bank loan obtainable for your business?
Generally, if you are profitable and have assets that are not collateralized, then you have a shot at obtaining a loan. Your odds increase even more if you know how to navigate the products available through the Small Business Administration (SBA). While the SBA does not give out loans, it provides guarantee programs that allow banks to make loans to businesses that would otherwise be considered too risky.
While this method is preferred, access to bank capital is challenging. By one measure, 80% of small business loan applications are rejected.
Method 2: Small Business Programs
Most states have small business lending programs. These are typically nonprofit lending institutions that have more flexibility than traditional banks. These organizations leverage investments and grants from financial institutions, foundations, government agencies, other nonprofits and individuals to provide capital to borrowers. Together with these funders, they serve small businesses and their communities in a sustainable and responsible manner.
An example of one of these organizations is the Colorado Enterprise Fund. If you are looking for one of these organizations, you’ll specifically want to search for Community Development Financial Institutions. Several of my clients have had success going this route.
Method 3: Crowdfunding – Non Equity
A host of crowdfunding sites – Kickstarter, Kickfurther – will help small business owners raise funds while not taking an equity position. One significant advantage of going this route is financing can be relatively quick. For instance, I have had clients close a campaign with Wefunder for over $100,000 in just over two weeks.
Another advantage of these routes is they often are much more flexible in their lending criteria. Crowdfunding may be a viable option for a company whose financial statements may not be considered for traditional bank financing.
The disadvantage of raising capital through this method is financing and interest costs. Typically, interest rates exceed 5% more than traditional bank financing. In terms of Kickstarter, companies typically must promise “investors” perks with a real cost.
Method 4: Crowdfunding – Equity
Other platforms, such as WeFunder and Start Engine (and several more) make traditional crowdfunding more accessible to small businesses. I could write a short novel on the advantages and disadvantages of these platforms. For this article, a couple of key points.
With this crowdfunding method, you will give up a portion of your equity in return for capital. There is no interest, but you may be subject to certain filings or communication requirements. Further, raising capital on these platforms can be costly. Many companies budget 20-25% of the expected capital raise in marketing costs. If you choose to go down this path, it is something you would want to work with an outsourced CFO.
Method 5: Lending Clubs & Online Lending
I will group these together because the economics and process are very similar. Several platforms such as Lendio, Kabbage, Funding Circle, and LendingTree offer quick, smaller loans to small businesses.
While initially appealing, lending products like these are expensive. It is not uncommon to see interest rates between 20-30% on these loans. I don’t typically recommend these for my clients, but there are scenarios where these might make sense.
Method 6: Friends and Family
I get it – you won’t be the most popular person around the dinner table if you keep hitting people up for money. But the reality is that friends and family fund more and more businesses then you think. Often investment in a small business can be appealing to people (who may not want to start one on their own).
For most of my clients that raised money, their initial round of investment is from friends and family. This type of funding can be either debt or equity. Typically a CFO or financial advisor can do a good job of helping both parties reach and agreement and see eye to eye on a transaction.
Method 7: Microlending
Microloans are very small, short-term loans with a low-interest rate, extended to small businesses and new start-ups with very low capital requirements.
They are business loans of up to $50,000 that can be used to start or grow a business. Nonprofit organizations are the most common microlenders. Many of these nonprofits are mission-based, focusing on lending to women, minorities, and other underserved entrepreneurs. Along with loans, many microlenders also offer free business mentorship, training, and assistance.
The SBA has the best microlending program. The interest rates are often very competitive and have repayment terms up to six years. The average SBA microloan is $13,000. Other providers include Kiva, LiftFund, and Opportunity Fund.
Method 8: Customers and Vendors
I have a few clients that have successfully secured funding from either customers or vendors. While this is less common, there are situations where this can make sense for both parties. For instance, I have a client who produces ethanol fuel as a byproduct of their primary business line. However, their future customer lent them the funds to purchase equipment to sell this ethanal. Why would they do this? As part of the agreement, my client had to supply a certain amount of fuel to them at a lower-than-market cost for a period of time. This made sense for both parties.
While this scenario may seem unlikely, I can tell you that I have a couple of clients that been successful in this route. The key is often laying out the advantages for both parties and being able to show a return to your partner.
Method 9: Small Business Investment Company
A small business investment company (SBIC) is a privately-owned investment company licensed by the Small Business Administration (SBA). Small business investment companies supply small companies with both equity and debt financing. They provide a viable alternative to venture capital firms for many small enterprises seeking start-up capital.
Small business investment companies supply money to small businesses, using capital they have raised and funds they have borrowed at favorable rates, thanks to loan guarantees provided by the SBA. The SBA does not make direct investments in small businesses. Its role is to help SBICs obtain leverage by guaranteeing their loan obligations.
To find a list of SBICs, look through the SBA’s website.
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