Three things you need to know about business financing
Our partners at Backd share the three things every business owner should know before taking on debt.
Business financing provides entrepreneurs with access to the capital they need to cover temporary cash flow interruptions, pay for equipment and raw materials, and plan for growth.
In recent years, more funding resources have become readily available, allowing business owners to easily apply and access the business financing they need. But with so much information out there, it can be difficult to determine what the best funding option is for your business. To help you decide, here are three surprising things you should know before you start your funding journey:
Understanding exact cost of capital is difficult
A key decision every business owner needs to make when raising funds is whether to opt for equity or debt financing.
While equity financing can seem like a cheaper option as it does not come with an obligation to pay back any money that is acquired, it does require that you sell a percentage of your equity within the company, meaning that you could surrender a good amount of control. Debt financing, meanwhile, allows you to retain all equity in your company, but you will need to pay back the amount acquired plus interest over time.
When it comes to debt financing, understanding the exact cost of capital can be challenging, especially as lending institutions aren’t always transparent about hidden fees. To determine the exact cost of capital, you can use a business loan calculator. You should also conduct thorough research to ensure that you understand the different finance products available, their benefits and their drawbacks.
For example, merchant cash advances (MCAs) can have a higher cost of capital, however they usually allow faster access to funds. Term loans typically have a lower APR, but they require collateral and a longer process to secure funds.
Keep in mind that higher interest rates aren’t always the wrong choice. Rather, it depends on your business needs and how your business will grow with the financing. How quickly you need capital for your business, how much your business needs or how much it can afford will determine the type of financing you need and ultimately the cost of capital available to you.
Success rate of acquiring funding from banks is low
It’s a sad fact that less than half of small businesses have their financing needs met. With the current economic climate, approval rates will likely decrease even further leaving small businesses with little access to the support that they need from banks.
Even when small businesses are successfully approved for a loan, it isn’t always what they are expecting. A Federal Reserve Bank credit survey found that around 14% of small businesses only receive a portion of their requested funds.
Many other business owners never complete the process, whether this is due to being debt adverse or simply feeling discouraged by the state of the system itself.
More and more businesses are turning to alternative lending as time goes on
32% of small businesses are now applying for loans from non-bank lenders, this percentage is up from 24% in 2017 and 19% in 2016. Traditional lending might help you eliminate a cash flow gap that your business is currently experiencing but this doesn’t make it a panacea for your business in the future. Regardless of how your financial position is impacted by a bad season or high overhead costs, alternative financing like working capital or a line of credit are often faster and easier than waiting for a traditional bank approval, which can take months and extensive digging into your personal and business histories.
Alternative financing is often used for short-term cash flow needs like expansion, equipment, or payroll. Taking advantage of a significant growth opportunity or addressing unexpected costs are also possible with working capital and lines of credit.
Technological advancements like AI programs that expedite the underwriting process and require less documentation for approval have resulted in alternative financing becoming a faster method to help small businesses expand. The speed of accessing capital allows business owners to focus on their growth.
Alternative lending also tends to be more flexible with lending terms and amounts. While banks don’t generally see it as financially prudent to lend amounts smaller than $250,000, some alternative lenders offer loans as small as $5,000 and up to $5M. Just under a third of small businesses have already started to turn to alternative financing with that number sure to grow.
Financing for your business
Ultimately, the type of business financing you need depends on your business needs. Whether that’s seed money, short-term capital, or larger expansion. Don’t be deterred by the slow process and low approval rate of banks. While the cost of small business loans will usually be the cheapest capital to raise, there are many funding options on the table.
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