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 of dollars 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 (less than $100,000). 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 capitalist 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).
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.
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.
Many small business owners might not realize that their business can have its own credit history and credit scores. 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's name and Employer Identification Number (EIN), which is essentially a Social Security number for businesses. 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:
- Create a business entity for your company (such as an LLC or corporation), get an EIN, open a business bank account, open a business-only phone line and list your business phone number in the 411 directories, which is a database of businesses phone numbers and addresses.
Each phone company maintains a 411 directory, and customers can access the directory by calling 411 and speaking with an operator or automated system. You can add yourself to the 411 directories by contacting the phone carriers or using a listing service.
- If you have an established business, determine whether you already have business credit files with the main business bureaus: Cortera, Dun & Bradstreet (D&B), the Small Business Financial Exchange (SBFE), Equifax, and Experian. These companies collect and store information about businesses and whether those businesses repay loans on time.
- 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.
- 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.
- 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.
Get a business credit card
A small business credit card can be great for separating business and personal expenses, both for tax reasons and building business credit. Business credit cards also offer business-specific perks, such as employee cards, which you can give to an employee to make business purchases. Some cards may also offer a bonus to new cardholders, or let you make purchases without paying interest during a promotional period.
Qualifying for a credit card can be easier than qualifying for a loan, but be sure to check the financial terms (such as fees and interest rate, called an annual percentage rate or APR) to determine if it's the right option for you. Search online or visit your local bank to discuss which small business card products could meet your needs.
Also, be aware that many business credit cards require a personal guarantee. Even though the card is in your business's name, you may be personally responsible for the card's balance. If your business falls behind on payments or your account gets sent to collections, you could owe the money and negative marks may be added to your personal credit history.
Debt may be necessary for many small business owners, especially when they're first starting out. Borrowing money can help you open and run your business, but interest payments are also a business expense that take away from your profits and can cause uncertainty.
In time, it's possible to get on solid financial ground and run a profitable, debt-free business. Alternatively, some business owners find that they can use debt to invest in their business and make more money than they spend on interest or fees.
Either option can lead to success. In both cases, figuring out when you should borrow money, and where you should borrow money from, are important skills for business owners.
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.
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. Learn more about small business debt consolidation.
File for bankruptcy, sell your business or close your business
Small businesses are not always successful in the end and may need to consider filing for bankruptcy, selling the business or closing entirely. If necessary, a sole proprietorship can file for Chapter 7, Chapter 11 or Chapter 13 bankruptcy.
Declaring bankruptcy can wipe out your debts so you don't need to repay the money, but it might also mean you have to close your business. It will likely affect your personal finances and employees, and you could have to pay taxes on the amount of debt that's wiped out.
If you formed a partnership, corporation or limited liability company (LLC), the business may be able to file for a Chapter 7 or Chapter 11 bankruptcy. You may still be liable for the business's debts if you signed a personal guarantee on a business loan, credit line or credit card. However, your personal assets could otherwise be protected.
Chapter 7 bankruptcy may require closing the business and paying off as much debt as possible by selling the business's property. With a Chapter 11 or Chapter 13 bankruptcy, you may be able to negotiate a manageable way to repay your debts while you continue to run the business.
During a bankruptcy case, you should still file all your required business tax forms and try to make your tax payments. Check out the IRS Bankruptcy Tax Guide for information on what happens to debts that are wiped out during bankruptcy, and tax information for different types of businesses.
Another option may be to sell or wind down your business without declaring bankruptcy, which could save you time and money as you can avoid the court system and attorney fees. There are companies and individuals that can help you list your business for sale and find buyers.
If no one offers to buy your business, you could try to sell your business's property and simply close the business. Before ending your lease, selling equipment and disconnecting utilities, talk to your lawyer and accountant. They can help you develop a plan to present to creditors, whose help and understanding you need during this process.
You can pay off as many debts as possible with the money you make from the sales and may be able to negotiate to a settlement that allows you to repay your lenders less than the full amount you owe. If you didn't declare bankruptcy and still owe money after this process, lenders may be able to sue you or your business to try and collect the money.