Start-ups and entrepreneurship are buzzwords in current times. It may be a hobby or passion that takes the form of a business, or it may be the need to solve a customer pain point; there can be many ways of starting off. Initially, every venture starts off small. It's only with a lot of perseverance and hard work that a business scales heights.
Among many of the inputs that a business requires to grow and expand, one of the important factors is finance. Funding can be raised in many different ways. It could bootstrapping (where the founders pool in the funds), sale of equity in the venture, sweat equity, debt, angel investors or venture capital funding, etc.
Though there seem to be many options, not all are available to a business. This is more true when the business is still small.
We have put together a guide to financing for small businesses that will make your business financing decisions easier and allow you more time to concentrate on operational issues of your business.
Here you go!
Establish Your Need for Finance
The first step that any founder or an entrepreneur should take is to establish a need for finance which is through making a business plan with details of projections of revenue and expenses. Once a plan is in place, you would have a rough idea of proportion of the funds that can be generated from your business and the proportion that needs to be funded from external sources.
Once this is done, you might also want to establish if the funds are required for a short term or over a long term. This might also be the right time to take a call on the nature of funding too, i.e. if you want to raise funds through debt or dilute your equity.
If you decide that debt is the way forward for you, then are various possibilities that you can think of.
We would like to categorize them under traditional and modern sources of finance.
What are the Features of Financing Available Through Traditional Sources?
By traditional sources of funding, we mean financing from banks and other non-banking financial institutions (NBFCs). Some of the features of raising funding from these sources are:
Stringent rules and regulations for borrowing
Heavier on documentation
Takes time for disbursal
Good Credit score of the business/ individual is a mandatory requirement
Minimum years of operation also forms a requirement for lending
Bigger businesses are preferred for lending over smaller enterprises
Loans from these sources are preferred for long term loans
Rates of Interest on loans availed from traditional sources tend to be low
What Are The Various Types Of Loans Available From Traditional Sources?
Traditional sources of financing offer various types of loans/ financing which can be selected as per the needs of the business. Some of the important ones being:
These are loans borrowed for a fixed period of time. They function much like a personal loan. The end use of these loans is not fixed and can come with or without a requirement for collateral. The rate of interest for these kinds of loans can range anywhere between 10-25% depending upon the credit score and other financial parameters of the business.
Equipment Financing is exclusively available for financing/ purchase of equipments. This kind of loan is more suited to manufacturing enterprises that have need for equipment. The asset purchased out of the loan is mortgaged with the lender till the period of the loan.
Working Capital Financing
Apart from assets or equipments, a business needs cash to meet the day to day expenses of a business too. It could be in the form of paying salaries, rent of the office premises, utility payments like water, electricity, and telephones, etc. Working capital loans can take forms like a business line of credit, cash credit, overdrafts, etc.
During the initial stages of a business, the founders are the heart and soul of the business, therefore founders can also avail of a personal loan to fund various requirements of running a business. Founders may find it easier to avail personal loans than a term loan provided they have a good credit score and a clear plan of repaying the amount borrowed.
Businesses could also consider using their business credit card as a method of financing short term needs. You could learn more about it here.
Factoring, Invoice Discounting, Merchant Cash Advances are also some of the other types of financing available from traditional lenders. These could be availed depending on the needs of the business.
Additional Reading: Types Of Collaterals You Could Offer For A Secured Business Loan
What are the Features of Financing Available Through Modern Sources?
Borrowing from modern sources of finance has become popular over the last couple of years. These lenders are also known as FinTech lenders and make use of technology to deliver credit to business owners.
The main features of this source of financing are:
Lesser stringent conditions for lending
Does away with the requirement for business credit score or credit rating
Faster processing and disbursal of loan
Less paperwork involved
Loans are lent for a shorter period of time
Interest rates could be on the higher end
Does not require collateral
What are the Various Types of Loans Available from a Modern Lender?
Online Term Loans
Just like a term loan from a traditional lender, fintech lenders are also open to lending for a term. However, the term of the loan offered is much shorter, often ranging from a few months to 3 years. The end use of the loan can be determined by the business owner. The rate of interest is a little higher than the traditional lenders and can range between 16-35%. The financials and the future potential of the business play a big part in deciding the rate of interest.
Online Lines of Credit
When the business is in the stage of development, it is often difficult to gauge the need for business finance. Smaller business cannot have the luxury of availing a bigger amount of loan and pay additional interest and at the same time, a smaller amount of loan may not be enough to fund the business requirements. In cases like these, businesses could go in for a line of credit.
With a line of credit, you can decide the maximum amount of credit that is made available to a business. From the given amount of credit, the business can withdraw sums as per the requirement. The plus point here being interest is charged only on the amount utilized.
Businesses can also explore other forms of online lending like Peer to Peer Lending or Crowd Financing.
The decision to go to a traditional lender or a fintech lender is a call that small businesses should make depending upon its requirements and other features of the loan. However, businesses in the stage of development should pay special attention towards ensuring that all loans are paid back on time so that they remain creditworthy and eligible for credit in future as well.