If the past year inspired you to build the business of your dreams, it’s time to start planning. There are many ways to finance a business, from traditional bootstrapping to peer-to-peer lending, and each of the options come with inherent pros and cons.
Read on to learn about all the ways to finance a business, along with the important things you need to consider with each financing option.
9 Ways To Finance A Business
In general, these are the most common ways to finance a business:
- Business loans
- Personal loans
- Business plan competitions
- Individual development accounts (IDAs)
- Peer-to-peer lending
Let’s look at each of these in more detail.
One way to finance a business is by bootstrapping it with your own money. The benefit of this is that you will not have to pay interest to anyone and there aren’t any hoops you have to jump through to access the money. However, this can be a problem if you do not have a lot of money saved. If you use your savings now and later your business runs into cash flow problems, you won’t be able to dip into your savings to bail yourself out.
Another bootstrapping option is to use the equity you have in any assets you may own. For example, you can get a home equity line of credit or borrow money from your retirement account. These options have more hoops you have to jump through than simply taking money from a savings account, and you will be charged interest and fees. There may be more money available for you to access, but there is also a higher cost to this money.
Another way to bootstrap your business is to use personal credit cards. If you only need a little bit of money fast, this could be a good option. Plan to pay the credit card off in full when it’s due so you can avoid paying any interest.
If you use credit cards to fund your business and can only afford the minimum payments, this is one of the most expensive ways to finance a business because credit card interest rates are so high.
2. Business Loans
A second way to finance a business is through business loans. Business loans give you access to a large amount of money. You will be able to leverage other people’s money to support your business needs. However, getting business loans is not always an easy process and in most cases they require you to have a formal business plan. You will also need good credit and collateral.
3. Personal Loans
A third way to finance a business is through personal loans. With personal loans, there may be less hoops for you to jump through and you may be able to get a low (or even a 0% interest rate).
For example, you may have a family member or friend who has access to money that would be willing to lend money to start your business. While this may seem like a great option, keep in mind that this option also has risks.
If you can’t pay back the loan, you need to think about how that will affect your relationship with the person who gave you the loan. You also need to think about how they will be affected if they never receive the money you borrowed from them.
4. Business Plan Competitions
You can also finance your business through business plan or startup competitions. The great thing about these is that it’s free money that you do not have to pay back and many times they also come with access to free business coaches and mentors!
As great as this option sounds, sometimes they do not allow you to win a lot of money so you might not have enough to start your business. They also require you to do a lot of upfront work and pitch your business idea in front of judges. It’s also necessarily competitive. You could do a lot of work and not win anything.
Ycombinator is probably the most famous competition, but you can find more on Growth Mentor. Also check colleges and universities near you to see if they have an entrepreneurship program or any business plan competitions that they hold or know about.
5. Individual Development Accounts
Another way to finance a business? Through a government program called Individual Development Accounts (IDA).
These are great if you only need a small amount of money. They are basically savings accounts that offer you a 200% return on your money up to a certain amount (generally $4,000).
For example, if you saved $2,000 of your own money, they would match it by 200% or put $4,000 into your account. You would then have a total of $6,000 to use for your business. One thing to keep in mind is that these are only available for low-income people and they have a business plan and workshop attendance requirement you must meet.
Click here to learn more about IDAs and see if you qualify.
This may seem like an easy option, however, these require a large upfront time commitment to create a good campaign as well as a solid marketing plan to share your business idea with the world. The websites also take a percentage of the funds you raise.
One last thing to keep in mind is that you need to be careful which website you choose. Some crowdfunding sites allow you to keep the money you raise if you don’t meet your goal. Other websites only give you the funds if you reach your monetary goal.
7. Peer-To-Peer Lending
You can also finance a business through peer-to-peer lending, with companies like Upstart. This is similar to a personal loan, however, it allows you to get personal loans from strangers.
Another one of the best ways to finance a business is to pre-sale your product or service. Basically, you take your customers’ cash up front and then use the money to purchase the supplies you need to make your product or service.
This is a great option if you can create something relatively quickly and you’re confident you will be able to deliver what you promised to your customers. That being said, you must be careful not to overpromise and underdeliver to customers. If you never deliver your product or service, you would be stealing their money and would have to deal with the legal ramifications of that.
Finally, another way to finance a business is by taking on investors. Unlike a loan where you need to pay back your principal plus an agreed-upon interest rate, investors won’t have a short term interest rate they charge. If you get an investor that is experienced in the business you are operating, they can also be a great resource to your business and its growth.
That being said, investors will typically own a percentage of your business and you will be required to share your profits and losses with them. They will also have a say in how you run your business. If you’re dealing with a savvy investor, they will require you to provide business plans and other material upfront, which may not be an easy or short process.
Now that you know nine of the most common ways to finance a business, all you have to decide is which option is best for you.