How to Fund a Small Business

So you’ve got a great idea and an entrepreneurial spirit. You want to start your own business, but there’s just one problem. You don’t know how to fund the thing.

Getting started with funding a small business is a daunting endeavor. Obviously, some businesses require more overhead than others, but no matter what your business of choice is, you’re going to need to spend some money to get started.

There’s no one right way to fund your business, and depending on what yours is, some options may be better than others. To help provide some clarity, we’re going to go over 7 different ways to fund a business. Let’s get started.

1. Small business loan

How it works

Fundamentally, business loans are really straightforward. You take money from a lender, and then you pay back the money over time plus interest. Any more detailed info than this and things get complicated. Let’s get into it.

First, where do these loans come from? There’s no shortage of lenders and they range from banks to credit unions to online lenders. Lenders will differ on details like interest rates and repayment terms.

In order to get a loan from a lender, you need to fill out a loan application. These applications are exhaustive and require tons of information from you—not surprising considering the lender might be giving you a nice little chunk of change. You’ll need to explain what you’re planning to use the money for, what experience you have running a business, and any other question the lender might have to qualify.

If you have trouble qualifying for a loan, you can get in contact with the Small Business Administration. They will work with you to try to help you secure a loan for your business.

For more info on business loans, take a look at this guide, which will walk you through what is required for different types of loans.

Pros

• Lenders have deep pockets
• Predictable repayment terms
• Typically low interest rates

Cons

• Long process with a lot of paperwork
• Potentially requires a personal guarantee (if you can’t repay the loan, the lender can come after your personal assets.

2. 401(k)

How it works

Typically, dipping into your 401(k) savings before you’ve hit retirement age is a big no-no, and doing so can result in huge tax penalties. But under certain circumstances, you can pull the money out without having to pay a fat tax bill.

The first step with this method is to consult a tax attorney. There are only a few steps, but you need to make sure you do everything properly to avoid penalties.

The steps are as follows. You first need to establish a C Corporation with a 401(k) plan. Then move your current 401(k) savings into the 401(k) associated with the C Corp. Once you’ve done that you can treat your new business as an asset and invest your 401(k) funds into your new business. Once you’ve done that, the money from your 401(k) will now be with your new business.

Again, to make sure you avoid any penalties here, consult a tax attorney before getting started with this method.

Pros

• Access to money you would typically have to wait until retirement age for
• No need to rely on external investors

Cons

• Risk losing your retirement savings if business fails
• Risk of tax penalties if done improperly
• Limited to the capital that exists in your 401(k)

3. Crowdfunding

How it works

Crowdfunding is a simple way to raise money that has been facilitated by the internet. In order to do this, start by finding a crowdfunding website; some you may have heard of include Kickstarter, Indiegogo, and GoFundMe.

On one of these sites, you create a page that promotes your business or product and you ask strangers for money (they don’t need to be strangers, but it was more fun to say it that way).

Typically, crowdfunders offer tiered rewards in return for contributions. For example, if someone gives you $50, you can give them some company swag. If someone gives $200, you can give them a free product. How you determine the rewards really depends on the nature of your business.

Pros

• Unlimited pool of contributors
• Extremely low risk
• Opportunity to build a relationship with early adopters

Cons

• Not effective for service-based businesses
• Difficult to market and get traction
• Rewarding contributors can be tiresome and costly
• Difficult to crowdfund large sums of money

4. Family & Friends

How it works

You’ve probably heard it said somewhere: don’t mix business and personal. Well, maybe. It’s not a good option for everyone, but in some cases, it does work.

There’s really no explanation of how this works because it can work however you and your family and friends decide. If you do use this method it’s wise to make it as official as possible. Establish clear terms to the loan and even use a third party to make loan payments.

By doing everything possible to make this feel like a real loan, you’ll go a long way in avoiding uncomfortable and sullied relationships.

Pros

• Better terms and rates than traditional loans
• Less risk if you can’t pay back the loan (materialistically, at least)

Cons

• Need I say it?

5. Find a partner

How it works

Starting a business all on your own is no easy task. There’s always more that can be done, and you probably don’t have the skillset to do all the things. One of those skills is having deep pockets.

Starting a business with a partner isn’t traditionally a funding strategy, but there’s no reason it can’t be. The difficulty here is finding a partner.

Get out and network, meet new people with similar interests. You might just find a partner who can help with funding your business.

A good example of this method in practice is in real estate investing. Let’s say you want to start flipping houses, but don’t have enough money to purchase that first house. If you find a partner who’s a veteran in the real estate investing game, you might be able to work out a deal where that person brings the money to the table and you bring the elbow grease. Then you two split the profits 50/50.

This is another one of those funding methods in which there really is no one right way to do it, but when done well, it’s a great option.

Pros

• Low personal risk if business flops
• Brings another skillset to your business

Cons

• You might not know what to expect out of your partner
• You now need to rely on somebody else
• Difficult to find a partner that accomplishes what you need

6. P2P lending

How it works

We have the internet to thank for this one. P2P stands for peer-to-peer, and rather than borrowing from a bank, platforms like LendingClub, Prosper, and Upstart connect borrowers with investors through an online marketplace.

If you’re looking to use P2P lending, the process is similar to getting a bank loan, though it’s typically a bit easier. Visit one of the P2P lending platforms, and there you’ll apply for the loan you need.

After you apply, you’ll be presented with a number of loan offers with different interest rates and repayment terms. Make your selection and the money will be deposited in your bank account.

Pros

• Easy and quick process
• No impact on your credit score when you check your interest rates

Cons

• Can be difficult to get approved

7. Angel Investor

How it works

An angel investor is a person who provides capital for a business. In almost all cases, angel investors only invest in early-stage startups or in individual entrepreneurs.

An angel may make a one-time investment or several investments over the life of the business. In return for the investment, angels typically take equity of a portion of the business. The relationship between an angel and the entrepreneur tends to be informal.

Pros

• Lender has a vested interest in your success
• Angel investors have deep pockets
• Little to no risk

Cons

• You have to give up equity
• Difficult to find an angel investor