The different types of startup financing
Consider these pros, cons and tips before you decide how to fund your small business.
Starting a business comes with a wide range of challenges, but how to fund it is often a major one. Getting a business off the ground costs $30,000 on average1, and records show 50 percent fail within the first five years.2 Many banks don’t offer small business loans until a business is established — in business at least two years — with a credit history and record of income. Until you qualify, you might be considering other sources of money. Explore the four most common below, including their pros, cons, what to consider and tips from Eric Tunbridge, senior product manager at U.S. Bank.
Fintech — short for financial technology — is growing in popularity. These startups tend to lend to businesses that might not qualify for a more traditional small business loan. To do this, they often use less traditional metrics for underwriting. For instance, one company looks at the number of UPS packages shipped and received.
"They're causing banks to re-evaluate how we do business lending. That innovation and change is good for the industry," says Tunbridge.
Tips: Read the fine print. Make sure you know the annual rate, the amortization schedule, prepayment penalties and more. These details can help you evaluate whether you can really afford the terms.
Global investment through crowdfunding is expected to reach $96 billion by 2025, according to the World Bank.4 Fundraising is often done via a third–party website, and investors often expect sample products, recognition or equity in exchange for their donation.
While this type of fundraising is used for more than just business ventures, many of the most popular fundraising campaigns have been for new products or businesses.
Tips: Read the fine print to understand what protections and liabilities you have before using these sites. While they can be a great and innovative source of funding, Tunbridge says, "There’s a lot of unknown risk. I would use it as a last resort."
Friends and family
It can be tempting to take money from people you know instead of pursuing more formal channels. But there can be strings attached. Beyond any potential damage to personal relationships, "It gets super complicated on the tax implications and the legal risks," says Tunbridge.
Tips: Have a frank conversation about terms and expectations before you borrow from friends or family. Be sure to discuss the amount, payment schedule and interest rate, then document what you decide.
Nearly 6 in 10 entrepreneurs use their personal savings to start their businesses.3 If you factor in personal credit cards, home equity loans and other personal funding, that number jumps even higher.
Tips: Legally registering your business with your state — as an LLC, simple partnership, S Corp or C Corp — can help limit some of your personal liability.
Create bank accounts and credit cards in your business’s name, even if you use personal savings to fund them. “Business lenders look for a credit history for the business itself, in the business’s name,” says Tunbridge.
If you’re ready for a small business loan, Tunbridge says there are a few criteria that lenders are sure to look for.
For details on obtaining a Small Business Administration loan, read this article.