At a time of high inflation and constantly rising interest rates, having cash available to small business owners is critical. Securing financing can be challenging and identifying the right type of financing can be critical to the success of your business.
Last week, the Federal Reserve announced that 0.75 basis point increase in its borrowing rate and indicated that further increases are likely to follow. For companies that need money to cover cash shortfalls or for growth plans, it is important to secure timely financing at a reasonable cost of capital.
Interest rates are rising
Cash flow is the lifeblood of any small business
Whether you’re an entrepreneur launching a startup or an established business poised for growth, securing the right source of funding can mean the difference between success and disappointment. Even if they are not in a growth period, small businesses need to have enough cash on hand to navigate sluggish periods and absorb increases in fuel prices, labor costs and raw materials. Shortages in the supply chain also affect the cost to easily meet demand.
The amount of financing a business needs depends on many factors, including the length of time a business has been in business, its current financial situation, credit history, the type of business, and how much financing is needed and what the money will be used for. Before borrowing, you’ll want to calculate the cost of the debt so you know for sure how much you owe in total.
Ways to Get Small Business Financing
Financing a small business can be challenging, but it’s not impossible. Typically, online or alternative lenders can provide your business financing faster than traditional banks. There are many options for financing a business:
- Personal Savings – If you want to do business, don’t expect to do it without putting some of your own money into it. Unless you are already independently wealthy, you will probably need startup capital. If you are planning debt financing, banks and other lenders expect you to put ‘skin in the game’. After all, if you’re not willing to invest your money in the business, why should they?
- Family and friends – There are many pros and cons to borrowing money from friends and relatives. You don’t have to provide your lenders with three years’ worth of tax returns, bank statements, and other documentation needed for a small business loan. In all likelihood, any interest will be low. But keep in mind that if family is involved, this could involve hiring a good-for-nothing cousin and receiving unsolicited suggestions — or worse, demands — about how to run the business from people who may not understand the business. . Keep in mind that relationships will get strained when things go wrong. How insistent will Uncle Ralph be about repayment if the company goes bankrupt? Getting into a family business has the potential to destroy family relationships.
- Traditional bank loans Securing a bank loan for small businesses is a proven method of accessing capital. Major banks typically offer the lowest interest rates, but they tend to be the most cautious when it comes to making credit decisions. According to the most recent, only a little over 15% of business loan applications from major banks are currently approved Biz2Credit Lending Index for Small Businesses (Figures June 2022). Before the pandemic, the number was over 28%. In general, the larger banks have the strictest lending criteria. If you have a low credit score or little to no credit history, getting a small business loan from a bank can be challenging. Furthermore, the process can take weeks or even months.
- Regional and Community Banks can be a good source of SBA 7(a) Loans, and typically smaller banks are more likely to approve loans. In June, they allocated 21.1% of applications received, according to the Biz2Credit index. However, that is very different from 2019 and early 2020, when more than half of the loan applications were approved. The good news is that smaller and smaller banks are partnering with fintechs and access online small business loans. These advancements are increasing the flow of capital to small business owners. This helps small businesses that are owned by minorities or located in deprived areas.
- Currently, the interest rates for business bank loans in the 4.25% to 9% range. But as the Fed continues to raise interest rates in an effort to fight inflation, we may see those rates go up in the near future. Also keep in mind that small business loans are often floating rate loans. That means the interest on the small business loan you received this year of 6.5% could be 8% next year.
- Alternative Lenders – Non-bank lenders that offer products such as cash advances to merchants provide a quick source of capital, have fewer requirements and will lend to business owners with low credit scores. These lenders take a higher risk in providing capital, so naturally they get a higher reward in the form of higher interest rates. Often these rates start at 20% and go much higher. But if an owner is in crisis or has the chance to make a deal with holiday stock at a spectacular price that can be sold at a high price, it can be worth it. With a cash advance from a merchant, the company quickly receives a prepayment — sometimes within 24 hours — that’s refunded as a percentage of the day’s credit card receipts. As with any loan, do your research and know what you’re getting into.
- credit cards – There are many stories of startup companies launched by the founders to “make the most of their credit cards.” While this route can be successful and the credit is instant, there are numerous stories of potential business owners getting into financial trouble by borrowing through their credit cards at interest rates that start at 12-14% or higher. Credit limits on the cards can severely limit the amount one can borrow. So, as the stories go, the owners use multiple cards. Using credit cards to start and sustain a business is risky and potentially financially devastating.
- Equity – Offering ownership interests to investors is a viable financing option. The challenge is to find the right investor. By giving away an ownership interest, you also give up control. Anyone who has seen an episode of shark cage will know this well.
- Government subsidies – The SBA offers limited grants for small businesses and grants to civil society organizations that promote entrepreneurship, including veteran-owned and disabled veteran-owned businesses and small business development centers.
Whether it’s challenging to get small business financing depends on your business’s revenue and profitability, the type of financing you’re applying for, and the amount borrowed. Other factors include your personal and business credit scores, time in business, and a solid business plan.
The bottom line: Carefully weigh your company’s financing options
Interest rates are not always the most critical factor. The speed of financing is often much more important. If you’ve run into a snag and are having trouble creating payroll, which is a major expense that continues to rise, quick financing is needed. Another reason why speed is essential: opportunity cost. Perhaps a supplier has decided to retire or is going bankrupt. You may have a chance to get a great deal on closeout merchandise. In such a case, the opportunity costs of not buying quickly are great. That’s when a loan from an online lender or an advance from a merchant makes a lot of sense.
