How should you fund your small business? Here’s how to choose.

The combined cost of opening up and running your shop, purchasing inventory, advertising, and paying your employees can leave you in the red for a significant amount of time until, hopefully, your business takes off and starts turning a profit. For minority-owned businesses, the challenges can be even greater, as they are disproportionately affected by insufficient access to capital.

It may be tempting to think that starting a business is simply a bad idea unless you happen to be sitting on a large pile of money. But of course, that’s not true. There are multiple ways for prospective business owners to obtain funding for their enterprise. Here, we’ll go over the pros and cons of six funding options for small businesses to help you choose the avenue that might be right for you.

Self-funding

What it is: Self-funding means, naturally, funding the business yourself. For obvious reasons, this is an avenue that’s not available to every entrepreneur. However, even if you are sitting atop the aforementioned pile of money, there are some important things to consider if you’re choosing to self-fund.

PROS:

• Complete control over decisions: Probably the single greatest advantage to self-funding is that it will allow you to retain complete control over your business. If you accept money from an outside source, you’re more likely to end up accountable to them, as they now have a literal stake in the direction of the business.

• Less time fundraising is more time for everything else: Fundraising from outside sources often means multiple rounds of investor meetings, dozens of drafts of your business plan, and generally, a whole lot of time spent worrying about things that aren’t running your business. If you’re able to self-fund, you’re also able to get that time back and focus it on the day-to-day of running and growing your business.

• It can be less stressful overall: Self-funding your business will free you from the stress of other people weighing in on your business decisions because they’ve bought themselves some equity by loaning you money. By putting up the money yourself, you get to run the exact business you want to run on your own terms.

CONS:

• You take on all the risk: Self-funding means you are responsible for all of the risk. If you emptied out your savings account to open your business, and the business fails, that financial burden is now entirely on you.

• Less high-level help: By self-funding, you may be missing out on one of the benefits of accepting funding from an outside source. People who invest in businesses usually want to make their money back, which means they have a literal vested interest in the growth and success of your business. Small business investors can become board members, advisors, and even co-founders that can help you grow and learn. If you’re funding the business yourself, it can be more of a challenge to find that truly invested top-level help.
  
• It’s a hustle on hard mode: Self-funding quite simply means that you’ll have to hustle a lot harder to make your money back and get your business profitable. That big upfront cost might mean you have less money left over for staffing and talent. It can mean that a lot of the initial day-to-day work will be left to you, and tasks like bookkeeping or building systemization can slip through the cracks.

Best for: Business owners with enough capital to put down. Businesses with a solid plan for growth and obtaining profitability.

Venture capital (VC)

What it is: Venture capital is one of the most common sources of funding for small businesses. Venture capitalists essentially provide the funding for businesses that they feel have strong growth potential down the line. They take on a lot of risk because of the potential for higher-than-average returns. Very often, venture capital is offered in exchange for an ownership share in the company (Yes, exactly like Shark Tank).

PROS:

• The money is (basically) yours: Venture capitalists understand that they are effectively gambling when they invest in a business. If the business succeeds, the gamble was more than worth it. If the business fails, they’re prepared to eat their losses. Unlike a bank loan, you usually won’t be obligated to repay a VC or angel investment should your business go under.

• It can help you grow and scale quickly: By providing a big chunk of money all at once, VC funding can help you quickly grow or scale-up your business. Let’s say, for example, you desperately need to hire more staff to manage an increase in orders. Without VC funding, you’d have to wait until you have the capital to spend on hiring efforts and an additional salary. With VC funding, you could just quickly solve the problem and keep growing.

• VCs have connections: Don’t forget that venture capitalists are also entrepreneurs, and have high-level business connections and contacts that you may be able to take advantage of. Forming a relationship with a venture capitalist can give way more than just money. It can potentially get you into the successful business circles you want to be traveling in.

CONS:

• You give up a stake in your company: Even if you don’t have to pay it back, VC funding usually comes with strings attached. Those strings are usually in the form of an ownership stake, or an equity share in your company. This dilutes how much control you really have over your business, and in some situations, you may even be giving up your ability to make controlling decisions at all if the business grows to a certain level.

• You can scale too early: One of the most frequent reasons that new businesses fail is they invest too quickly in hiring and scaling before they’re profitable. The Silicon Valley model of “move fast and break things” might be attractive to entrepreneurs, but it’s led to more business failures than success stories.

• You’ll have to fundraise: You probably didn’t start your business because you love public speaking, but if it’s VC funding you want, the first thing you have to do is get comfortable with the idea of pitching your business over and over again to a skeptical audience. Business owners who are seeking VC funding have a really solid pitch that’s rehearsed, tight, and inspires confidence. Plus, you’ll have to sink a ton of time into follow-up meetings.

Best for: Businesses with high growth potential and a clear plan for scaling, or businesses experiencing sudden growth they can’t keep up with.

Bank loans

What it is: A traditional bank is a good place for any entrepreneur to start looking for funding. Banks offer a couple different funding options for small businesses, and can also help you assess where you stand in terms of accessing a loan or line of credit.

PROS:

• Low interest rates and good terms: Generally speaking, banks offer small business loans that are low interest and have competitive terms. They may not be as game-changing as a VC investment, but they can help you out and tend to be pretty up front about what they want from you in return.

• Retain complete control: Unlike a VC investment, a bank loan won’t come with the caveat of someone being interested in an ownership share in your company, which means you’ll get to retain complete control of your business. The tradeoff, of course, is that bank loans have to be paid back with interest.

CONS:

• They’re hard to qualify for: To get a bank loan, the bank will want to see a clear business plan that includes growth projections, expenses, credit rating, and other details that will help them decide how much to loan you, and how confident they can be that they’ll get their money back. On top of that, the application process can be lengthy and filled with procedural red tape.

• You’ll have to get good at pitching: Bank loans are another situation where you have to not only have all your books in order as a business owner, but also know how to pitch yourself and inspire confidence in the lender. Banks hear tons of pitches and requests for loans, so some good thought will need to go into what will make you stand out as an entrepreneur, and what will help you secure that loan over someone else.

Best for: Established businesses with collateral and strong credit.

Small Business Administration (SBA) loans

What it is: An SBA Loan is a small business loan backed by the federal government. Essentially, the U.S. Small Business Administration can offer a federal guarantee on loans you receive for your business, which makes it less risky for the lender (usually a traditional bank) and can lead to lower interest rates for you.

PROS:

• They’re easier to qualify for than traditional bank loans: Since they’re backed by the federal government, SBA loans can be easier to qualify for than a bank loan. However, you’ll still need to meet certain qualifications — namely a good credit score (FICO 690 and up), strong annual revenue, and at least two years in business.

• Lots of help is available: The SBA has resource centers and counselors who are there to help with any questions you may have about qualifying for a loan or growing your business.

CONS:

• Approvals can be slow and complicated: SBA loans take lots of time to process, and can leave you buried under a mountain of paperwork before you know it. There’s also many different types of SBA loans, and sorting through the different options will take some effort.

• They come with personal liability: SBA loan seekers will usually have to make a down payment and/or put up collateral for a larger loan. If your business fails, you will also be personally responsible for paying back the debt in full, and the lender has the right to seize any collateral you’ve put up.

Best for: New or established businesses who want lower interest rates on their loans or don’t qualify for traditional business loans.

Crowdfunding

What it is: Crowdfunding through a site like Kickstarter is a way to seek out lots of little investments instead of one big loan or cash infusion. It doesn’t always work, but when it does, it can be a good way to simultaneously build an audience and customer base while you launch your business.

PROS:

• Access to capital with no debt: Unlike with a traditional loan, a crowdfunded business doesn’t start off in debt. The investments here are essentially donations, and even if you’ve built in perks to incentivize people to donate, the money itself is yours.

• Market testing is built in: If you decide to crowdfund your business idea, and it takes off, you’ve also just done a free market test. You know you have a customer base who is willing to put up cash to support your business. That’s more than a lot of businesses start out with.

CONS:

• They have a low success rate: The elephant in the room with crowdfunding is that the vast majority of the time, it simply doesn’t work. Unless you’ve got a mind-blowing product, or a business idea that really captures people’s imaginations, chances are your crowdfunding effort will not raise the capital you really need.

• It’s a big marketing campaign: Even the most successful crowdfunding campaigns require a near constant marketing push to get over the edge. People aren’t naturally inclined to spend money on someone’s idea for a business, so you’ll be constantly pushing the message out to whomever you can, asking for donations, and building in incentives. All of that is time you could be spending on a business plan, or pursuing a more traditional and less risky type of funding.

Best for: Established businesses that already have a community following.

Small business grants

What it is: Small business grants are basically free investments. They’re essentially a donation with no strings attached, usually offered by nonprofit organizations, government agencies, and some corporations.

PROS:

• It’s free money: A no-strings-attached infusion of money for your business? Who would say no?

• Unique opportunities for under-represented groups: Many small business grants are offered to business owners from marginalized communities, or groups that are under-represented in the business community. There are specialized small business grants for women business owners, Black business owners, veterans, and more.

CONS:

• It’s free money: That means that everyone wants it. Applying for a small business grant is highly competitive. Tons of businesses are eligible for them, and you’ll have to put in a lot of effort to stand out in the application process. 

• It’s time consuming: With tons of different grants available, and tons of different qualifications for all of them, you can spend a lot of time researching a grant and writing up a perfect application. If you’re denied the grant, that’s time you won’t really get back.

Best for: Business ideas that have community interest or products that can capture the public interest.

There’s nothing more fundamental to the start of your business than securing funding. Whatever your business is, take some time to think about what kind of capital you need to get started, and where best to obtain it. There are pros and cons to every type of small business funding, and there are of course risks associated with the whole process. Make sure you’re doing lots of research and asking lots of questions in order to find the funding path that’s right for you.

Other articles you may like

• How to start a small business in 9 simple steps
• How to finance a restaurant
• How to open a business bank account

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This information is provided for informational purposes only and should not be construed as legal, financial, or tax advice. Readers should contact their attorneys, financial advisors, or tax professionals to obtain advice with respect to any particular matter.