Access to capital is frequently one of the most significant roadblocks that entrepreneurs face in trying to start or grow a business. Traditionally, small business loans have been a goal or steppingstone for small business owners of all calibers, while investors and venture capital are the end goal for startups aiming for rapid growth.
However, entrepreneurs are not monolithic. Not everyone wants to go the startup route or pursue explosive growth. And when it comes to SMBs headed by women, minorities, and other marginalized groups, access to traditional sources of capital becomes even more difficult. This has led to an explosion of alternative sources of capital and new methods of raising funding that can either lead to more traditional methods or provide an ongoing funding source or fallback option.
Is it easier to get capital today after all, or do the same barriers persist?
When Personal Funds Are Not Enough
According to the Kauffman Foundation, 64.4% of entrepreneurs are starting out with their own savings, while only 8.7% have the backing of family or friends.
If you want to keep your operations small, self-funding is often the goal. But for most entrepreneurs, self-funding in the beginning is also how you prove to banks and investors that you're invested in your ideas. After all, if you won't put up money for your own business, why would they?
Personal funds are often the ideal for solopreneurs because there are no restrictions on your own money. However, one of these other types of capital will have to come in when personal funds inevitably run short.
Understanding Different Types of Capital
Debt Financing
Debt financing can come from traditional lenders like banks and credit unions in the form of small business loans. There are also alternative lenders that work with new small business owners who may not have good credit, or enough credit at all, to get a traditional bank loan.
Credit may also be revolving like a line of credit through a bank or a credit card.
Ultimately, business loans offer lower interest than credit cards. However, approval may take a long time, and the application process for just one lender could be lengthy, not to mention the time it takes to shop around for different rates and terms.
Banks need you to have a good reason for seeking the loan, such as an expansion or equipment purchase to finance, and also tend to favor capital-intensive businesses such as restaurants or landscaping companies. This is because there are vehicles and equipment that could satisfy any unpaid debt in case the owner defaults on the loan. For intellectual property-based ventures, it is often difficult, if not impossible, to get a small business loan without significant collateral.
Credit cards can damage your personal credit if used improperly or utilized too heavily, and they carry extremely high interest rates. However, the ultimate benefit is that you can use the funds for any reason and the credit card issuer doesn't care so long as you make the payments.
Equity Financing
Traditional investors will own part of your company in exchange for a future share of your profits. Investors can be accredited angel investors who specifically seek out startups with potential for rapid growth, or local businesspeople who see potential in your ideas and want to take the chance on funding you.
Incubator programs are another form of equity financing in which a group of investors provide more hands-on mentoring to help grow your business and steer it in the right direction, and these programs have grown in prevalence in recent years.
Typically, angel investors exit through an IPO or M&A, while small-time investors exit through buyouts.
Alternative Non-Debt Methods (Factoring, Crowdfunding)
Digital payment processors such as PayPal offer "factoring" funding by taking a percentage of your future income or receivables in exchange for smaller amounts of upfront cash. This type of financing does not entail a credit card or lengthy application, as they go by prior transaction history and determine how much they will lend based on those numbers.
Crowdfunding first came to prominence in the early 2010s with the advent of Kickstarter, then numerous creative and business ventures began seeking funding this way by providing rewards instead of paying interest or giving up equity. Crowdfunding is more difficult to successfully pull off today due to the large number of campaigns that failed to deliver or disappointed backers upon delivery.
Entrepreneurs still gravitate to one or both of these methods if their credit is poor and/or they have a significant enough following on social media or other channels to risk a time-consuming campaign.
Business Grants
Some state and local governments offer grant funding to SMBs, often to encourage economic mobility among marginalized groups (particularly government contractors). There may also be a specific need for new businesses in economically distressed areas.
Grants can have many strings attached with drawn-out application processes and ongoing monitoring after funds are received. Depending on the nature of the grant program, it can be worth pursuing if traditional capital sources are difficult to get.
Ultimately, the best source of capital depends on your business goals and how soon you need the funds. Other factors like your personal needs, current burn rate, and creditworthiness need to be considered as well.
Martinez & Shanken, PLLC writes for CountingWorks, an accounting news and advice website. Reach the firm at [email protected]
About Martinez & Shanken, PLLC
Martinez & Shanken, PLLC is a Certified Public Accountant (CPA) firm based in Gilbert, Arizona. We provide a full range of accounting, bookkeeping, consulting, outsourcing and business services. Partners Deborah Martinez and Earl Shanken work to ensure your business accounting is done with integrity and to your satisfaction.
