Oct 9, 2019
Small business lending is an exploding field. With crowdfunding, marketplace lending, and venture capital financing, there’s no shortage of options available to the small business owners of today.
Unfortunately, many entrepreneurs aren’t aware of their options. Even if you know what’s available, you may not know how to get started. That’s where this guide comes in.
We’ll be looking into many of the major funding options available to entrepreneurs and how those options may or may not be relevant to your business strategy. There’s a lot out there, so we’ve organized this guide into 5 sections, each detailing a particular kind of small business financing.
Feel free to hop to any section that interests you. Or buckle your seatbelt, turn on your favorite song, and get ready for a trip through the jungle of small business financing.
This one’s a real classic among entrepreneurs—hitting up your rich Aunt Mayberry for a little holding money to get your business off the ground. It’s a tale as old as time, but unfortunately, these tales tend to end in damaged family relationships and endless awkward Thanksgiving dinners.
It’s simple: loans from people you know and love usually mean easy approval, all paid interest stays in the family, and your “lender” is more likely to be flexible about payment arrangements.
Also, you often can borrow 100% of the required amount and enjoy lower interest rates. A national survey by Fundable found that 38% of startups rely on money lent from family or friends. These kinds of deals are common, but there are some serious drawbacks to structuring them incorrectly.
The one thing you want to avoid overall is damaging your relationship with your loved one. Difficulty in personal loans usually comes as a result of the lendee being unable to pay the lender back but can also appear in the form of misunderstandings.
To avoid the kinds of misunderstandings that plague personal loans, you must have a detailed discussion with your intended lender. These are the crucial details you must discuss:
There’s more than one way a family member can finance you. They can put together a loan agreement where they lend you money at a given interest rate. They may also decide to gift you the money without the expectation of repayment. Or, they can offer to cosign a loan application.
Cosigning is a way for your family member to use their credit to help you get a bank loan. That way, their money isn’t at stake in your venture. Their credit is, however, so be sure they’re aware of the risks of cosigning as well.
Sometimes arguments arise when family members think that their loan means they can order you to make business decisions. Be sure to outline exactly how involved you want your family member to be in the process before accepting any money.
Also, absolutely tell your family member to talk with the IRS about any loans they intend to offer you because they could end up with tax issues at the end of the year if they don’t follow IRS guidelines for family loans.
Once they know the risks and are ready to lend to you, make sure you draw up a legal document. Basic terms for a loan agreement with family or friends should include:
The loan agreement should also clearly state the lending party’s recourse in case of nonpayment, including:
A 2017 survey by Lending Tree reported that 1 in 4 people who lent money to family or friends said the situation was not positive and the same number said they wouldn’t do it again. Most of the time, loans between family and friends don’t work and hurt relationships.
In the end, family lending is a sloppy business but one with some benefits. Avoiding common mistakes can keep relationships intact, but involving family in finances is always risky.
Securing a loan from traditional lenders has been a problem ever since the 2008 recession. The housing crisis backed a lot of banks into a corner and forced many of them to impose heavier restrictions on their lending practices.
This change ultimately meant fewer loans for small businesses and those businesses that did secure loans had to be doing very well and have an air-tight business plan.
However, banks are still a viable option for seasoned business owners who need extra capital. Just be ready for a mountain of paperwork. That’s right, an actual mountain.
Below is a list of the kinds of information and paperwork most traditional lenders require to approve financing for interested parties. Behold the mountain:
The traditional loan application process usually takes around 29 hours to complete. And what do you get after all of the time and turmoil spent applying? Usually nothing. Banks clock in an 80% rejection rate.
If your credit isn’t superb, it’s not worth the time investment to fill out an application for a bank loan. Your best bet for securing one of these loans is to have stellar credit and an impeccable business track record.
If you are one of the lucky few who get approved, you’ll usually have to wait for 2–3 months to find out. After those months have passed and you’ve gotten approval, you’ll then have to wait 90 days before the funds are transferred into your bank account.
It’s an arduous process that takes a long time, but once you reach the finish line, you usually have a pretty good loan product with a decent interest rate.
But if you don’t fit the category of stellar credit and an impeccable track record, where are you supposed to go? Not to worry, you’ve got options.
Marketplace lending came in clutch when the banks started choking back on small business loans. Even though the supply of loans plummeted after the 2008 recession, the demand held strong and even increased.
Digital and internet technologies made starting small businesses more viable to enterprising individuals in addition to providing the key innovative footstool on which technology-based lending platforms like marketplace lending could be built.
Rather than forcing applicants to spend several hours filling out paperwork, lending marketplaces fast-track the application process by using a single online application to match business owners with financing options from a variety of lenders.
At Lendio, for example, our application takes a whopping 15 minutes to complete. That’s shorter than an episode of Seinfeld and just barely longer than the time it takes to boil some Cup Noodles.
Also, lending marketplaces boast a 70% approval rate for applicants. At Lendio, once your application is complete, it’s sent off to more than 75 accredited lenders. That’s 75+ chances to get approved after a 15-minute application compared to a 20% traditional loan approval rate after a 29-hour application process.
Also, it’s common to start getting approved for loans within the first 24 hours of applying. Best of all, with a lending marketplace you have options. Not only will you likely get multiple offers from Lendio’s partners, but you’ll get offers of all kinds to fit your specific business needs.
Here are some of the loan products Lendio offers to small businesses that fill out the 15-minute application:
The business term loan is a classic among entrepreneurs. Loan amounts vary from $5,000 up to $2,000,000, and you’ll often get the cash within a few days of being approved. The term of the loan is from 1–5 years, and the interest rates usually start around 6%.
Short term loans are lightning-fast, getting you money in as little as 24 hours. The amounts range between $2,500 and $500,000 and have interest rates that start at 8%. Because these loans can be approved so quickly, they’re perfect for when your business needs fast cash. The term of the loan is between 1–3 years.
Need a new breakroom fridge? Maybe you need a tractor, an industrial stapler, a shiny milkshake machine. Whatever piece of equipment is going to take your business to the next level, that’s the one an equipment loan will help you purchase. Amounts go up to $5,000,000 with interest rates starting around 7.5%. And the money can be available after a couple of short days.
These loans range from $50,000 up to $5,000,000. The paperwork for these puppies is almost as bad as a traditional loan, and approval and disbursement of funds can take up to 3 months. But securing one of these bad boys means getting yourself a loan with highly favorable rates and terms.
Also, these loans are tailored to small businesses, so they’re easier to get approved for than a bank loan despite a long and arduous application process. The SBA guarantees a portion of these loans, which reduces the lender’s risk and leads to more generous approval rates.
While our 15-minute application won’t land you an SBA loan, it will put you in contact with our lending professionals who can help you apply for one through our lending partners.
We’ve only scratched the surface of the kinds of loans Lendio offers via our marketplace, but we can’t talk about ourselves forever despite the temptation to geek out on our awesome stuff. (We’re a little biased, can you tell?)
But despite how great lending marketplaces are (in our opinion), there are still a few options we haven’t covered yet. Let’s jump into them.
Crowdfunding is an exploding industry “with over $2 billion raised via equity and reward crowdfunding in the United States in 2015 alone,” says the Harvard Business Review.
It’s a great space but only for a specific type of business. When people think of crowdfunding, they often think of Kickstarter. Kickstarter’s crowdfunding is reward-based—consumer investors usually expect to receive a copy of whatever product is being funded.
Crowdfunding works for businesses looking to fund product development and dispersal. It’s not particularly good for anything else. It’s important to note that 5% of all pledge money goes to Kickstarter, so you’ll have to run the math before popping your product ideas on the site. If your calculations show desirable profit margins, then crowdfunding is a viable option.
One bright side of crowdfunding for female entrepreneurs is that women tend to outperform men on these sites. Recent research shows that women are 13% more likely to succeed in raising money on Kickstarter than men.
So if you have a crack marketing team and a shippable product, crowdfunding may be a viable option. If not, do not fear—there are still other options.
Angel investing makes for great television. There’s nothing like watching Mark Cuban lob hard-hitting questions at hungry entrepreneurs looking for a financial boost. It’s sensational, but here’s how it boils down in the real world.
Angel investors and venture capitalists (VCs) differ on 3 points:
Angel investors are usually a single wealthy entrepreneur interested in helping a small business grow. Investors in venture capital funds are a collection of large institutions such as pension funds, financial firms, insurance companies, and university endowments.
Angel investors typically invest in young startups. Venture capitalists, on the other hand, invest in slightly older companies with solid bottom lines. According to Bill Gerber, cofounder of the virtual accounting firm AccountingDepartment.com, $5 million in annual revenue is the magic number at which venture capitalists will start to consider investing in a company.
Finally, VCs invest more money than angel investors. According to the Small Business Administration, the average venture capital deal is $11.7 million, while the average angel investment is $330,000.
Venture capital investing and angel investing are similar in that entrepreneurs ask for financing in exchange for equity in their businesses. According to Crunchbase, “the median and average level of VC ownership at exit was 53% and 50% respectively. In other words, by the time of exit, VC will likely own half your business.”
In both situations, entrepreneurs lose some control over their businesses as the investor becomes a crucial decision-maker in the future of the company.
Additionally, venture capitalist groups tend to be very industry-biased. In the second quarter of 2019, $12 billion of VC funding went to businesses in the internet space. Health care came in a distant second with $4.6 billion.
In other words, if you have the specific kind of business investors are looking for, your financials are top-notch, and you’re OK with losing some control, then angel investment or venture capital may be the way to go.
There you have it—a guide to most of the popular funding channels. Whichever one you choose to pursue will be based largely on the needs of your business and the kinds of financing you can qualify for.
You know we’re a little biased towards Lendio’s sweet marketplace, but our 15-minute application is a good place to start if you’re ready to compare your options right away. Once submitted, your application will be capable of scoring you a plethora of loan offers from our 75+ lending partners.
It’s the comparison shopping of small business financing and here’s the best part: those 75+ lenders are all competing for your business. Get started today.
Andrew Mosteller is a freelance writer and regular contributor to Lendio News. His upbringing in an entrepreneurial family nurtured a passion for small business at a young age. Andrew's father, an equity fund manager, taught him the ins and outs of investment financing. Now, Andrew spends his time writing copy for business owners, helping them expand and advertise their unique brands. He's also studying Strategic Communications at the University of Utah. When Andrew's fingers aren't glued to the keyboard, he spends his time reading, podcasting, composing music, and bombing down the ski slopes.
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