Financing

Self-funding
Otherwise known as bootstrapping, self-funding lets you leverage your own financial resources to support your business. Self-funding can come from tapping into your cash savings, money from a job or investment accounts. If you own a home, you might be able to use your home to take out a new loan. With this arrangement, the lender will be able to take your home if you can’t afford to repay the loan.

With self-funding, you maintain complete control over the business, but you also take on all the risk yourself. If your business doesn’t work out, you might lose your savings or home.

Consider how long it could take you to rebuild the savings you use, and whether you can truly afford to lose them. To be on the safe side, check with a personal financial advisor before taking action.

Friends and family
Some business owners rely on funding from friends and family members. These investors know you, the skills you bring, and your passion for the business, and they are generally rooting for you to succeed. They also may be understanding if your credit isn’t perfect.

While friends and family may be excited to help you start or grow a business, be sure to thoroughly explain the risk they’re taking by supplying funds. Also consider the risk to the relationship and what might happen if you’re unable to repay the money.

It’s a wise idea to write up a formal agreement, with terms for how you’re going to repay the loan and whether they’re buying partial ownership of the business. Depending on your relationship and how complex the agreement is, you may want to hire an attorney. Otherwise, if you both agree, a less formal written agreement that you both review and sign could work.

Loans
Many financial institutions offer loans for starting or running a small business. Be sure to shop around to compare interest rates, repayment lengths and potential loan amounts. 

When you apply for a loan, most lenders will require you to show your business plan and a variety of financial documents. These could include bank statements and tax returns from the previous few years. If you’re starting a new business, your own finances and credit could be a major factor in the lender’s decision. Businesses that are well-established may be able to qualify for a loan based on their business finances and business credit. But, even then, the owners’ finances and credit could be a factor.

Some local and non-profit organizations may be able to help you prepare a business loan application and steer you toward the lenders in your area that generally offer business loans.

Investors
Investors can give you funding to start your business or help take it to the next stage. This type of funding usually takes the form of venture capital investments or angel investing.

Venture capitalists usually offer larger loans to somewhat established businesses in exchange for partial ownership and an active role in the company. Venture capitalists typically:

• Focus on companies that they expect to grow quickly, such as doubling in size within a year or two.
• Invest in companies that might make tens or hundreds of millions each year.
• Don’t offer a loan. Instead, they buy partial ownership of your company.
• May offer a larger investment than you would get from traditional financing, such as a bank loan.

Venture capitalists generally invest other people’s money through a venture capital fund and may expect a seat on the board of directors in exchange for their investment. So be prepared to give up some portion of both control and ownership of your company in exchange for funding.

Angel investors tend to focus on helping businesses that are just starting out with relatively small investments. Your friends and family could be considered angel investors, but there are also individuals who invest in strangers’ businesses. Angel investors may also want to buy ownership in your company, but they tend to take a less active role in the companies they help fund.

Venture capital funds and angel investors have their own criteria for the types of business they invest in, the requirements for making an investment and what they hope to gain in return. But no matter who you ask for an investment, be prepared for the investor to carefully review your business plan, finances and experience (a process called due diligence).

Seller financing
Some business owners buy an established business rather than starting one from scratch. If you’re considering this path, you could inquire about seller financing. With seller financing, you have to pay for a portion of the purchase upfront (called a down payment) and borrow the rest of the money from the seller. You then repay the loan, plus interest, over time.

The benefits of seller financing are that the seller gets to earn interest on the loan, and you can be assured the seller believes in the business’s potential and future. You may even be able to negotiate a smaller loan in exchange for letting the seller keep partial ownership of the business.

You should review the loan offer carefully, and compare the payments to your business plan and budget to determine whether you’ll be able to afford the loan payments. The seller may be able to take back the business and business assets if you’re unable to repay the loan.

Crowdfunding
Some businesses are financed through crowdfunding, which involves collecting donations or investments from many people — usually online. There are three basic types of crowdfunding:

• Donations, where others invest in your business without expecting to receive anything in return.
• Rewards, where donors receive a "reward," like a free product sample, once the fundraising goal is reached.
• Equity, in which donors receive partial ownership in a new company or venture.

While crowdfunding can be a great way to increase awareness and exposure, there are risks associated with it as well. If you fail to meet fundraising goals, it can negatively impact the reputation of your business. It’s also unpredictable — while some crowdfunding campaigns are very successful, many are not.

Review your local laws before trying to raise money through equity crowdfunding. Special rules can apply to businesses that are trying to sell equity, and you don't want to break the law right as you're starting your business. If you can afford one, you may want to hire an attorney who has experience with equity crowdfunding. If not, you can thoroughly research the topic on your own, or even reach out to the government organization that oversees equity crowdfunding for help.

Business credit

Although business credit scoring varies from country to country, the general principle of maintaining a healthy credit history is important. Many small business owners might not realize that their business can have its own credit history and credit scores (where applicable). Business credit can be just as important as personal credit, and building business credit could help you access the financing that you need to pay for a large expense, manage your monthly bills and grow your business.

Getting credit for your business is similar to building your own personal credit, except it's linked to your company. A company with good business credit has a record of responsible financial behavior, while one with poor business credit has a history of late payments or unpaid bills. As a small business owner, your personal credit can still be important. Lenders may want to review an owner's personal credit, and this could be a factor in determining your business credit score.

Good business credit could help you get better terms when you need to borrow money. It can also be crucial for negotiating agreements with vendors and renting business equipment. Monitoring your business credit reports could also warn you if someone tries to use your business's name to borrow money.

These steps can lay the groundwork for building business credit, but be sure to do research on your local business credit system before taking out credit:

1. Create a business entity for your company.
2. If you have an established business, determine whether you already have business credit files with a business bureau. These companies collect and store information about businesses and whether those businesses repay loans on time.
3. Establish a business credit history by taking out lines of credit, credit cards or loans in your business's name. Ask the lender which business bureaus it reports to (some don't report to any, which won't help you build business credit). Having terms agreements, in which companies let you pay for your purchases over time, with suppliers and vendors can help if they report your payments to the business bureaus. Some bureaus also let you self-report information about your business.
4. Understanding what influences your business credit could help you take steps to build credit. However, there are many business credit bureaus, and each uses a different calculation to determine your score. Paying your bills on time generally helps, and paying bills early might be even better. Some of the factors are out of your control. For example, the industry you're in and how long you've been in business could affect your score.
5. Monitor your business credit reports for unusual activity, such as a new loan or account that you didn't open. Unexpected changes could indicate someone else is using your business's good credit to borrow money.

Understanding debt load
The total of all the money you owe is what's commonly known as your debt load. To determine whether your debt load is more than you can afford, you can calculate your debt-to-income ratio (DTI) by comparing the amount you owe to the amount you earn.

This gets a little confusing because in business finance you use "revenue" (not "income") to describe the money a business makes. Income generally describes business profits.

However, for the DTI calculation, you use the business's "gross income", which is the same thing as revenue — the income before expenses.

You can calculate your DTI by dividing your total monthly debt payments by your total monthly gross income (or revenue).

Lenders may consider your personal and business DTI when making a lending decision. For example, they might not approve a loan if your DTI is over 30 percent (you spend 30 percent of your revenue on debt payments). You can also use this information to help determine if it's wise to take on additional debt.

Generally, a DTI ratio of 10 percent or less means that your finances are very healthy, and ratios within a range of 10 to 20 percent represent a good standing. At 20 percent or above, it's time to assess your debt load. Creditors will be less likely to give a loan to someone with such a high DTI ratio, and creditors that do lend in these circumstances tend to charge high interest rates.

You could decrease your DTI by paying off loans, lowering your debts' interest rate or payment amount and increasing how much money you make. A business may be able to do this by offering promotions to increase sales, charging customers a late-payment fee to encourage on-time payments, asking your vendors if you can repay them over time, cutting out unnecessary expenses or consolidating debt.

Consolidating loans
When you have multiple loans, you might want to take out one large loan and use it to pay off several smaller loans. If you get approved for a lower interest rate than you're currently paying, consolidating loans may lower your monthly payment amount, save you money on interest, simplify your repayment process and make it easier to track how much you owe. There are several methods to consolidate your business's debt.