Getting financing, for many entrepreneurs, is about as much fun as going to the dentist. You’ll need to figure out what you need, get your financial paperwork in order, and be prepared for rejection. But it’s also crucial. After all, every business needs cash to grow – and one of the big reasons that entrepreneurs fail is lack of funds.
Last week, Forbes asked small business owners, entrepreneurs and those who had dreams of launching a new operation to tweet us questions about getting funding. We got questions from all over the world – from as far away as Abuja, the capital of Nigeria. The main questions focused on the key inter-related issues of what to do first, how to get financing, how to know if you’re getting a good interest rate, and what to do if you have less-than-stellar credit. There were queries regarding eBay financing options. Others sent questions about specific industries, such as food. I’ll address four of these questions in detail below.
1-What’s the first step in trying to acquire funding from financial institutions for your startup?
This question came from Chicago, and it’s a good one. The first step, even before you go to a financial institution, is to know what you need – and why you need it. “Sometimes business owners confuse the challenges they have in their businesses with needing to borrow money,” says Sam Graziano, chief executive of Fundation, an alternative lender. Maybe you need to raise your prices to bring in more money, or to cut your expenses, or to get better at collecting the invoices ballooning your receivables, rather than borrowing funds. So if you’re looking for financing, know why you want it, and what you plan to do with it once you get.
The next question is what you qualify for. What you want to do is rank your options in terms of their attractiveness – and take whatever is the best deal for you. The cheapest option, if you qualify, is an SBA loan. While the stats on small business owners get rejected for bank loans are bad, if you’ve got cash flow from your business and good credit, and are willing to put up your home as collateral, you may qualify. “Obviously a bank loan is going to take longer to close, but it is going to be the lowest rate,” says Jared Hecht, chief executive of Fundera, an online small business loan aggregator.
If you don’t qualify for a bank loan, then you’re looking at alternative finance. There are a lot of different types of alternative financing; some are decent, and others are so expensive that paying it back could put your business in jeopardy. If you qualify, look for financing with a decent interest rate (realistically, in the mid-teens, if you don’t qualify for bank financing), a lengthy payback period, and no prepayment penalty. Ask what your APR or effective APR will be so that you can compare the financing options you’ve got. Be wary of using short-term financing, like a merchant cash advance, for anything other than truly short-term needs, like buying inventory. Before you sign any paperwork, be absolutely clear no only how you’ll repay the debt, but how you’ll expand the business with it.
2-How can a small business owner with low credit and low income find funding?
One of the ironies of financing is that the more you really need it, the harder it is to get. Not only will small business owners with low credit and low income have a tougher time finding financing than those with stellar credit and oodles of cash coming in, but the cost of it will also be higher – and sometimes much higher. I’d be willing to bet that Opportunities Unlimited, a business networking group in Tuskegee, Ala, which asked the question, knows this well from its members.
If you don’t yet have a track record (at least two years) with your business, and you don’t have a good credit score (say 600 or more), your options may be limited to cash advances, invoice financing or other shorter-term, higher-cost options. That makes it even more important for you to be clear about why you’re borrowing, and to shop around to avoid the sharks. But just because you’ll have to pay more than creditworthy business doesn’t mean there aren’t options, some of which are better than others. For example, the new invoice financing players like BlueVine and Fundbox offer better rates and more transparency than traditional factoring. Similarly, cash advances and short-term capital come with a vast array of rates and terms. PayPal’s working capital, for example, generally translates to effective rates in the mid-teens or low-20s, versus some lenders’ rates in the 40s, 50s, 60s, or higher. Make sure that your financing doesn’t have a prepayment penalty; that way if you’ve got the funds you can pay it off sooner without it costing you so much.
Finally, if you do go with a cash advance now because of poor credit or low income, don’t just keep rolling over the debt. Instead, you’ll want to come up with a plan for not only paying it off but getting cheaper financing once you qualify for it. That’s what Michael Zadeh, founder of ZadehKicks, a Eugene, Ore.-based reseller of athletic footwear, did recently.
Zadeh started selling athletic shoes on eBay, a few pairs at a time, six years ago. As the business grew, he put in $30,000 of his own money and took out a merchant cash advance – which led to another cash advance and then another one, until he’d taken 10 or 12 of them from multiple lenders, with payback terms between three months and nine months. “They make it very convoluted to find out what you’re paying,” Zadeh says. “The worst one I did, I’m pretty sure, was $75,000 at $110,000 payback. As long as I’m flipping my product frequently, I’ll still make money, but I have to work my butt off to pay all that interest.”
Four months ago – with sales now approaching $2 million – he ditched the cash advances and lined up less pricey credit with alternative lender Dealstruck. Today, Zadeh has an inventory line of credit up to $240,000 at an interest rate of 18.99% and a $70,000 term loan for 12 months at an APR of 22%. The new financing, he says, has given him breathing room. “I’ve flipped inventory a ton of times since then,” he says, “and done a lot of big deals.”
3-How can I be certain I’m getting the best interest rate for my loan?
Good question. With interest rates so low these days, you may expect that your business loan will be as cheap as your mortgage. It won’t be. But what’s a fair rate? And how do you know if you’re getting the best deal you’d qualify for?
Small business owners are awash in offers for financing, and many of those offers are bad. Even a decent small business loan can run in the double digits, say 12% or 15%, and a cash advance can go to 40% or higher. (Cash-advance players skirt the usury laws by not defining their financing as loans per se.) What’s a fair rate for you depends on the cash flow of your business, your personal credit rating, and whether you’re willing to put up collateral, among other issues.
Unless you can get a bank loan, there’s no way to know for sure if you’re getting the best rate. But you can be smart about shopping for a loan. You can compare loans with the help of a reputable loan broker, such as MultiFunding or Fundera, either offline or online. The better your business’s prospects and your credit rating, the better the rate you’ll qualify for. And even within categories of loans, there are huge differences. You might be offered a three-year term loan with an interest rate of 9% from one lender, and basically, the same loan with a rate of 15% from another, says Fundera’s Hecht. The spread can be even wider among cash advance lenders: You could be offered financing that works out to a rate in the 20s or in the 40s, or even 65%. Unless you get approved for an SBA loan, don’t just take the first deal you’re offered.
4-What is the best method for raising capital for new food products?
Chef J., of Los Angeles, lobbed over this question, which makes me wonder just what deliciousness he’s cooking up out there. The issues with raising capital are the same regardless of the industry: What are your business’s prospects? What’s the cash flow? What financing can you afford? With one big exception: Since food businesses are notoriously low-margin, they may be more difficult to fund. “When we look at low-margin businesses, we like to see a fairly diverse base of customers,” says Fundation’s Graziano. “Businesses that are low-margin and don’t have a diverse customer base are hard to lend to.”
If that’s your situation, there’s one additional alternative: crowdfunding. Instead of taking on debt, some entrepreneurs are turning to Kickstarter and other crowdfunding sites, asking friends and supporters to chip in for “rewards” or advance sales. I wrote last month about a startup knitting business, Sh*t That I Knit, that went this route in September, hoping to raise $15,000 to buy new yarn and crank up production for the holiday buying season. Result: With three days to go on their campaign, they’ve surpassed their goal, raising $23,486.