Why businesses need financing and funding

Operating a successful business takes more than a good idea and hard work. It requires capital to purchase equipment, lease space, pay employees, and promote the business.

Like many business decisions you must make, when and how you fund your business depends on several factors. They include the amount of money you need, how you plan to use it, and how much you're willing to pay for the cash.

Top reasons businesses need financing and funding

Businesses seek funding sources for a variety of reasons. They typically use the cash to expand operations, increase production, or meet operational costs.

Expand operations: The business may purchase real estate, lease a larger facility, or invest in new technology to keep up with industry shifts.
Increase production: The business may need to purchase or lease new equipment that will speed up production or start offering new products and services to customers.
Meet operational costs: The business may need extra cash to cover expenses until it generates enough income from sales to pay the bills.

What are some types of financing and funding available for businesses?

Several financing and funding options are available for businesses. Small business owners should choose carefully to find the right type for their business needs.

Debt financing: Debt financing is borrowing money and repaying it over a set period of time. You keep control of your company but must be able to make the payments.
Equity financing: Equity financing is borrowing money in exchange for ownership in the company. You don't have to pay back the money, but you give up some control of your company.
Mezzanine financing: Mezzanine financing is a combination of debt financing and equity financing. You may find it easier to qualify for this type of financing, but you may lose control of the company if you cannot make the payments.
Rollover for business startups: Rollover for Business Startups is borrowing from a retirement plan to start a business. You won't pay early withdrawal penalties or loan costs, but you risk losing your retirement savings.
Merchant cash advance: A merchant cash advance is a loan paid back through a percentage of daily receipts. This is convenient if your business income fluctuates, but this option can cost more money over time than other options.
Grant: Money given by a government authority or other organization for a project that benefits a community. You don't have to pay back money from a grant, but you do have to use it for the purpose stated in the grant guidelines.

Financing and funding sources for businesses

When it's time to seek financing and funding for your business, where do you go?

Businesses turn to many different sources when they need cash.

SBA: The Small Business Administration doesn’t directly lend money to a business. If your bank turns down your loan application, you can apply to the SBA for an SBA-backed loan.
Grants.gov: offers a database of grants available through the Federal government. Some corporations and non-profit groups also offer grants, but you may need to spend some time searching for them.
Financial institutions: Commercial banks and credit unions typically offer business loans and merchant cash advance services to customers.
Private investors: Private investors are individuals or groups who invest in your business in exchange for repayment with interest or ownership. They may or may not be your friends and family.
Family and friends: Your family and friends may agree to lend you money for your business in exchange for repayment with interest or ownership in your company.
Crowdfunding: Crowdfunding refers to the practice of seeking small contributions from many people. You may use social media or a crowdfunding site to find investors.
Microlenders: Microlenders are nonprofits that receive loans from the SBA. In return, they then make small loans to small businesses. In general, microlenders offer loan amounts lower than commercial banks.

How to qualify for financing and funding

Just like when you apply for a mortgage or auto loan, the lender wants to know that you can pay back what you borrow. You can increase your approval chance with some preparation before you complete the application.

Evaluate the health of the business. Carefully examine your business's liquidity, solvency, operating efficiency, and profitability. How much cash can you quickly access? Can you pay your bills? Can you earn a profit? More cash won't necessarily help a business that can't make money.
Assess your capital needs. How much money do you need? How much money can you afford? Make sure you will be able to pay back the money you borrow, or that you have the resources to meet grant requirements.
Decide how you will use the funding to make the business more profitable. Is it time to expand or renovate your operations? Do you need to purchase new equipment? Are you waiting for customers to pay invoices? How will these changes increase profitability?
Know what the funder or lender wants to see. Lenders want to know that you can pay back the money you borrow and that you're going to use the money responsibly. Show them your business plan and your detailed plans for the money.

What prevents businesses from getting the money they need?

Businesses don't always get the financing and funding they need. This is especially true for businesses owned by minorities or women and businesses in rural areas. They are less likely to apply for loans and to be approved for loans than businesses owned by men and in urban areas.

Understanding the reasons businesses don't get approved for loans and other funding sources can help you avoid those errors.

Lack of Collateral: Real estate and equipment can be used to pay back your loan if you default on it. A lender may deny your request if you don’t have collateral to offer.
Poor Credit History: Lenders look at the creditworthiness of the business and business owner. A poor credit history may keep you from getting a loan.
Large Debt: If you've already borrowed money, the lender may believe you have trouble managing or making money.
Low Income: If the business does not produce enough income, the lender may question whether it has the potential to turn a profit and pay back the borrowed money.
Not Enough Capital Investment: Lenders like to see that owners have a personal investment in the business.
Industry Failure Rate: Banks approve fewer than 20% of the business loans they receive. Startups and businesses in industries with high failure rates, such as restaurants and retail stores, are typically less likely to qualify for a loan.

How can I make my business more appealing to investors?

Give lenders and investors a reason to give you money. Here are a few actions you can take right now

Write a business plan. A business plan gives lenders important information about your company, including a list of products, target market, and financial statements.
Improve your credit. Take a close look at your personal and business credit reports. Resolve negative items that appear. Pay down outstanding debt and find ways to increase income.
Purchase tangible assets. Consider investing in real estate or equipment that you can use as collateral for a loan
Invest in your business. If you haven't already invested in your business, you may want to do it now. This can be through money or a real estate or equipment purchase.

Next steps

Learning about your financing and funding options is just the first step toward securing the money your business needs.

Here's a list of what you can do next to prepare if you're seeking financing and funding for your business.

Write a business plan: Writing a business plan allows you to think about the structure of your business and your plans for its future.
Clean up your credit: Pay your bills on time. Work to pay down your credit cards and lower your debt.
Search for available funding: Make a list of potential lenders for traditional banks and microloans. Explore grants available from federal and local government agencies as well as corporations. Even if you're not ready to apply, you'll be able to review the requirements for each funding source.

The information in this article was obtained from various sources not associated with Adirondack Bank. While we believe it to be reliable and accurate, we do not warrant the accuracy or reliability of the information. Adirondack Bank is not responsible for, and does not endorse or approve, either implicitly or explicitly, the information provided or the content of any third-party sites that might be hyperlinked from this page. The information is not intended to replace manuals, instructions or information provided by a manufacturer or the advice of a qualified professional, or to affect coverage under any applicable insurance policy. These suggestions are not a complete list of every loss control measure. Adirondack Bank makes no guarantees of results from use of this information.

Article written by EVERFI

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