According to a recent study by JP Morgan, the vast majority (88%) of businesses in the US have fewer than 20 employees, and nearly 40 percent of all companies have under $100k in annual revenue. So, if you think your small business is really small, turns out you’re right in the middle of the pack!
So how do these businesses get their financing? There are three main avenues of financing for small businesses: debt financing, investment financing, and grants. We’ll explore all three here, but we want to focus on grants, since this method of raising capital for a business is not as well known as debt or investor financing.
Debt Financing for Small Business
Perhaps the clearest, though not the easiest, option to get the capital required for a small business is to go to your local bank and borrow it. Sounds easy, but it is much more complicated than that. Here are some things you must do and consider in order to get a business loan from a bank — any bank.
- Do you have a relationship (existing accounts) with the bank already?
- How is your credit score?
- Have you created a complete, professional business plan?
- Do you have financial projections for your business for at least 3, perhaps even 5 years?
- How much cash will you personally be able to invest in the business?
- Will your business support both the payback of the loan and your personal income?
These are just a few of the questions you’ll need to have answered before you walk into a bank seeking a loan to fund your business. Generally, banks are financially very conservative, meaning they are not known for taking big risks. According to the SBA, about 20% of small businesses fail in their first year, and about 50% of small businesses fail by their 5th year. With those statistics in mind, a bank will need to see evidence that (a) your business will be among the 30% that succeed beyond 5 years, and (b) even if it doesn’t, that you’ll pay back the loan.
Investor Financing for Small Business
Investors are known for taking more risks than banks; however, investors still want their money back, and with a high rate of return on their investment. That means that, not only should you be prepared to demonstrate everything you needed to demonstrate for a bank loan, but also that you’ll be able to deliver to your investors their desired rate of return. That return usually comes in some sort of “exit” event, meaning that you sell your business or take the business public. An IPO is not usually an option for a small business, though being acquired can be, if the business is in a market that is consolidating.
The more important part of your effort to raise capital from investors will be your relationship with them. In a small business or startup investment, the investors are usually investing in the entrepreneur. That’s you. If they know you, your history, your competence and capabilities, then their confidence will already be high before they even see your business plan.
Before you ask for investment dollars, make sure you build relationships with the investors.
Small Business Grants
Finally, small businesses can apply for grants to capitalize their operations. We covered the basics of loans and investor financing because there are many similarities to grants; however, there are a lot of differences, too.
First, what’s similar among loans, investments, and grants?
- You’ll need a solid, professional business plan
- There will be a lengthy application process
- A relationship with the granting organization will help a lot
- There will be expectations for the results of the money from the granting organization
Those are the big similarities. Some of the differences include:
- You don’t have to pay back a grant
- The granting organization does not take an ownership interest in your business
- There is no interest nor expected return on investment for a grant
These differences make it seem like a grant is “free money”, but do not assume that’s so. There are entire seminars on how to apply for and earn grant money. But, believe it or not, applying for a grant may actually be the easier part of the process. What’s the hardest part of getting a grant for your small business? Finding the right grant.
Government Grants vs. Private Grants
A quick search for “Small business grants” brings up the SBA’s grants page, which provides a solid introduction to exactly what the US Government is currently providing grants to accomplish. Add your state name in front of that search, and you’ll get more specific, local information about how to apply for grants in your community.
There’s no such thing as “free money”. At the very least, you will have to put in hours applying for a grant, which includes detailed business plans, forecasts, and other documentation. However, knowing that you have (at least) three options to raise capital for your small business operation can open your eyes to many more possibilities.