Financing a small business

No matter what line of business you go into, you will need start-up capital to get your business going.

What you need to buy can also depend on the degree to which you want to separate your business from your personal life. Many people will use their personal vehicle, cell phone and a room in their home to meet these needs inexpensively. Incorporating to separate your business assets and liabilities from your personal ones also costs money, but it offers an extra layer of protection if your business fails.

You should also consider operating costs that you’ll pay regularly in the course of running your business. Some of these may be required before you set up shop and on an ongoing basis thereafter, like insurance, membership fees and dues, loan payments and employee wages.

Sources of start-up capital

How much money you can afford to risk on your business from your personal savings and how much money you need to open for business will determine whether you need to look elsewhere to raise start-up capital. Let’s consider the pros and cons of each potential money source.

Personal savings

Personal savings are commonly used by business owners to help pay for start-up costs. You won’t incur any interest expense when you use your own money to finance your business. You also won’t have any creditors to pay back, and no one will come after you for money if your business fails or isn’t successful right away. On the other hand, most people have already earmarked their personal savings for other uses, like retirement and a rainy day fund. Unless you already have plenty of extra money lying around, you might want to start setting aside some of your savings each month to put toward your business. You might also be able to tap your home equity, but it’s a big risk to tie the success of your business up with having a place to live.

Business loans

Banks provide business loans to finance vehicles, equipment, real estate and other expenses. These loans are generally for a short term, such as six to seven years, but the duration can often vary based on the type of financing required. Some type of collateral generally must be used to secure the loan – usually the vehicle, equipment or real estate being purchased with the loan, or a blanket lien on other assets. Expect to pay a loan origination fee and, of course, interest. Business loans can offer the security of a fixed monthly payment and a fixed interest rate, although variable rate loans may also be available.

Some banks may only offer loans on large amounts; if you need to borrow less than the minimum requirement, seek other financial institutions to provide a more accommodating loan or dip into your personal finances. You might also want to finance your equipment and vehicle needs with a line of credit or a conditional sales agreement.

If you plan to seek a loan from a bank, be prepared to provide a detailed explanation of how much money you need and for what purposes, as well as a detailed explanation of how you will be able to repay the loan. The bank may want to see recent personal income tax returns, bank statements, credit history and other personal financial information.

Credit cards

You can always use a business and/or personal credit card to pay your business start-up costs, assuming you already have or can qualify for a credit card. However, unless you have a card with the required limit and a low interest rate that you will be able to make regular payments on, credit card financing can quickly get you in trouble. You don’t want to borrow money for your business at a 20 per cent interest rate because the balance will grow each month and it can become very difficult to pay off the debt. Sometimes it is possible to get a card with an introductory interest rate as low as zero per cent. If you take advantage of an offer like this, make sure you have a plan for paying off the money you borrow before the card’s interest rate goes up.

Business line of credit

A business line of credit should have less rigorous qualification requirements than a business loan. It is similar to a business credit card in that it is an unsecured loan and you can use it as you need rather than borrowing a lump sum all at once. It can be used to refinance debt as well as to finance working capital, payroll and all the same types of expenses as a credit card financing. It is typically designed to be a short-term loan and may have a variable interest rate and an annual fee. Some banks may only offer large business lines of credit, such as $25,000 and up, so this may not be the right option for you if you only need access to a small amount of credit.

Family and friends

Are you willing to risk your personal relationships by mingling them with money? Only you know the nature of your relationships with friends and family, and whether any of these people are a viable source of financing. But if your business goes under, would you rather have to explain to a stranger or to your best friend that you’re not sure when you’ll be able to pay them back? Mixing friends and family with finances adds yet another risk to your business endeavor – the risk that you’ll ruin a close relationship. Nothing can strain a relationship like money. Merely asking for it can be enough to introduce awkwardness into an otherwise sound relationship. If your dad won’t lend you start-up capital, you might find yourself thinking, “How can my own father not believe that I have what it takes to succeed?” It’s much easier to be rejected for a loan by someone who doesn’t know you because you’ll know it’s purely a business decision, not a personal one.

Venture capital

Pursuing venture capital means bringing someone else, generally a stranger, into your business as a partial owner. If retaining control of your business is important, you shouldn’t consider this financing option. Usually, you will not receive any profit yourself until your investors have profited from your business. Additionally, this type of financing limits the entrepreneur’s upside potential since venture capitalists will often require majority ownership of the business. On the other hand, the majority of the downside risks are also assumed by the lending party.

How much capital do you need?

There is no one-size-fits-all method for determining start-up capital needs because each business has unique requirements. Basically, you need to make a list of the start-up items specific to your business and research each one to determine its cost.

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