Small Business Funding and Financing Glossary
If you’re thinking about starting a business, or want to make improvements or expand your existing business or you just need money to get through a lean stretch, here is a glossary of funding options to help you find what’s suitable for your specific needs.
Many think that angel investors and venture capitalists (VCs) are the same, but there is a major difference. While VCs are companies (usually large and established) that invest in a business by trading equity for capital, an angel investor is an individual who is more likely to invest in a startup or early-stage business that may not have the demonstrable growth a VC would want.
Convertible debt is when a business borrows money from an investor or investor group and the collective agreement is to convert the debt to equity in the future. Convertible debt can be a way to finance both a startup and a small business, but the borrower has to be comfortable with releasing some control of the business to an investor. These investors are guaranteed some set rate of return each year until a set date or an action occurs that triggers an option to convert.
Crowdfunding on platforms such as Kickstarter and Indiegogo can give a financial boost to small businesses. These platforms allow businesses to pool small investments from several investors instead of seeking out a single investment source. It is important to read the fine print of different equity crowdfunding platforms before choosing one. Some platforms have payment-processing fees or require businesses to raise their full financial goal to keep any of the money raised. Best for business-to-consumer startup businesses.
One of the easiest ways of getting a loan with bad credit. Most businesses that purchase expensive equipment can qualify, as the equipment bought or leased with the loan doubles as collateral. If an owner opts for equipment financing, they should keep the equipment in good working condition and avoid using the loan on equipment that will soon become obsolete. Otherwise, payments are made on useless equipment.
With factoring, a service provider fronts the small business the money on invoices that have been billed out, which the business repays once the customer settles the bill. This way, the small business has the cash flow it needs to keep running while waiting for customers to pay their outstanding invoices. These advances allow companies to close the pay gap between billed work and payments to suppliers and contractors. Best for business owners who invoice their customers.
Businesses focused on science or research may receive grants from the government. The U.S. Small Business Administration (SBA) offers grants through the Small Business Innovation Research and Small Business Technology Transfer programs. Recipients of these grants must meet federal research and development goals and have high potential for commercialization. Best for mission oriented startup businesses.
MERCHANT CASH ADVANCES
A merchant cash advance is the opposite of a small business loan in terms of affordability and structure. While this is a quick way to obtain capital, cash advances should be a last resort because of their high expense. A financial provider extends a lump-sum amount of financing and then buys the rights to a portion of the small business’ credit and debit card sales, taking a small cut of each sale until the advance is paid back. If an entity can’t qualify for a small business loan or any other options, only then should merchant cash advances be considered.
With strategic partner financing, another player within an industry funds the growth in exchange for special access to the business product, staff, distribution rights, ultimate sale or some combination of those items. Partner financing is a good alternative because the company a small business owner partners with is usually a large business and may even be in a similar industry or an industry with an interest in the startup business.
PEER-TO-PEER OR MARKETPLACE LENDING
Peer-to-peer (P2P) lending is an option for raising capital that uses websites to connect borrowers with lenders. Lending Club and Prosper are two of the most notable P2P lending platforms in the U.S. This form of lending, made possible by the internet, is a hybrid of crowdfunding and marketplace lending. When platform lending first hit the market, it allowed people with little working capital to give loans to peers. Years later, major corporations and banks began crowding out true P2P lenders with increased activity.
SMALL BUSINESS LINE OF CREDIT
Like a loan, an unsecured line of credit provides a business with access to money that can be used to address any business expense that arises. Unlike a small business loan, there is no lump-sum disbursement made at account opening that requires a monthly payment. Interest begins to accumulate once a business owner draws funds, and the amount paid (except for interest) is again available to be borrowed as the owner pays down the balance. As with a credit card, the lender will set a limit on the amount allowed to borrow. Most businesses use these funds for operational expenses like supplies and payroll or for increasing inventory. Cyclical businesses often rely on an unsecured line of credit as a source of off-season working capital. An unsecured line of credit is not designated for a specific purpose or purchase. Best for small businesses looking for ways to better manage cash flow.
Venture capitalists (VCs) are outside groups that take part ownership of a company in exchange for capital. The percentages of ownership to capital are negotiable and usually based on a company’s valuation.The benefits of a VC are not all financial. The relationship a business establishes with a VC can provide an abundance of knowledge, industry connections and a clear direction for the business.
Source: Arkansas Business