Business Financing Options: The Top Sources of Funding for Small Businesses
October 23, 2023
Running your own business means wearing many hats — and when you’re looking to secure business financing, that means stepping into the role of CFO.
“Managing finances can be one of the most challenging responsibilities for business owners, but knowing what kind of loan is most appropriate for your situation helps ensure you get the best deal,” says Dina Kempski, regional SVP of Business Banking at Northwest Bank. “When used properly, business credit can provide the necessary capital to manage changes in cash flow and set you up to grow.”
We’re here to help you make sense of your options. Read on to learn more about the top financing options for small businesses — including the advantages and considerations for each — and the steps you can take today to set your application up for success.
The first option for financing your business is also the simplest: Invest it in yourself. This “bootstrapping” method can include using your personal assets to finance the business, as well as using the business’s profits to fuel further growth. You might opt to tap into your home equity with a home equity loan or line of credit, for example, use an inheritance to launch your business or cash out the balance of a 401(k) rollover to self-fund.
Self-funding offers a significant amount of freedom: With your own funds on the line, you’re in total control of how you use the money and how to grow your business.
But it also puts your own money at risk. “You may run out of money before your business breaks even or turns a profit,” says Kempski. “Even if you use retained earnings, you often have a slower path to growth than if you sought external funding.”
Using your own money may negatively impact your financial security — and if you use the balance from a 401(k) rollover, the distribution may have tax implications, as well as the potential to impact your retirement plans. Make sure to balance the risks and rewards to determine if it’s the best choice for you.
Pro tip: You also have the option to take on investors, who provide financing in exchange for equity in your company.
Investors can add value to the business, including expertise and connections. However, you may need to compromise on the direction for the business — and, because you’ll own a smaller percentage of the company, you’ll get a smaller share of the profits, Kempski says.
Small Business loans
One of the most common ways to finance your business is by taking out an installment loan. When you’re approved, you’ll gain access to a lump sum that you pay back in agreed-upon installments.
Business owners generally have two types of options for business loans:
- Secured loans: Secured loans are issued directly by a lender, like a bank or other financial institution. They generally offer competitive interest rates and are intended for established businesses.>
- SBA loans: SBA loans are backed by the Small Business Administration and issued by a lending partner, like a bank. In order to qualify, credit-worthy businesses must be located in the United States and meet SBA size requirements as well as other eligibility criteria.
Both loans have their benefits and considerations. Secured loans generally allow established businesses to save money on interest, but they may not be accessible to every business. SBA loans may be more accessible to newer businesses, but come with lengthier application times, because the SBA must ensure your eligibility. You can shorten the process by working through an SBA Preferred Lender — a lender who is able to make lending decisions without approval from the SBA — such as Northwest Bank.
A trusted lender can help you rethink your financing needs as your business evolves to ensure your loan continually meets your needs, says Kempski. “If you’ve had an SBA loan for two to three years, we can work with you to refinance and convert it to a secured loan to help you lower your rate.”
Lines of credit
A business line of credit is a flexible form of financing that operates like a credit card, allowing you to use money from your credit line as needed. Like a credit card, you only pay interest on the amount you use, and you can re-use the funds as the principal balance is paid down.
However, it may be difficult to rely on a line of credit alone to finance your business. “Business lines of credit usually have limits much lower than an installment loan. If the line has a limit lower than your needs, it just sets you up to accumulate debt without accomplishing your goals,” says Kempski.
Instead, consider asking your lender to include a line of credit within a conventional loan to get the best of both worlds: a larger lump sum to cover your major financing needs and a line of credit as a cash buffer.
How to get a business loan
These four steps help set your application up for success.
1. Refine your business plan
Creating or updating your business plan is an essential first step toward securing financing, says Kempski. “A business plan lets us know how much money you need as well as how you plan to spend your financing, and it signals to us that you’re an organized entrepreneur.”
As a bonus, writing your business plan doubles as a crucial strategy session and can help you refine your business direction and goals before you approach lenders.
2. Maintain strong financial records
Lenders will look at your business’s financial documents when deciding whether to extend you credit, so ensure you have the financial fundamentals in order.
“No matter how busy they are, successful businesses take the time to keep careful accounting records,” says Kempski. “By doing so, they know where their business stands financially and can often get a better and earlier grasp of any potential challenges they might be facing.”
3. Know your credit score
As a business owner, your personal credit matters. “Even if you have a business credit score, personal guarantees are extremely important to secure business financing, as you need to personally guarantee that you’ll pay back the loan if the business is unable to,” says Kempski. “I recommend every business owner pull their free credit report and take steps to improve their score if needed.”>
4. Evaluate potential lenders
If you’re interested in a loan or line of credit, set up meetings with a handful of lenders in your area to discuss your options. You’ll have a chance to learn which types of loans may be available to you, as well as get a sense of whether the lender feels like a good fit.
Pro tip: Lender Match can help you locate lenders in your area that distribute SBA loans. To save time on the application process, look for an SBA Preferred Lender, such as Northwest Bank.
When choosing a lender, you should compare rates, fees and other details to find the best option for you. But it’s just as important to find a lender that believes in your business, says Kempski. “Pick someone who will be by your side after the loan is approved, who can offer support as you expand and grow.”
Making the right choice early can set your business up to grow. You’ll not only meet your banking needs, but get support in other key areas of your business — such as tax planning, succession planning and operational support — that will help you succeed.
Get support reaching your business goals
From business financing to tax planning and beyond, our dedicated team is here to help your business grow. Find a Northwest expert near you to learn more about our business lending options, or to discuss your business needs.