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Your startup business is an important part of the economy. It drives innovation, creates jobs and supports local communities — just to name a few examples. Yet, you likely face a common challenge on your path to success: securing the necessary funding. While you may try to finance your small business with your own capital or borrow from family or friends, there are other options available. In fact, Forbes Advisor Survey states that 42.4% of startups use small business loans to help kickstart their companies.
In this article, we’ll explore common small business expenses, the types of financing options and the reasons why funding is critical for your startup.
Understand Common Business Expenses
Several types of costs are incurred when starting a business. Depending on your business, you may not need to account for these expenses in the beginning but might face them down the line. For instance, you may decide to not hire employees until the second or third year you are in business. Here are a few common business costs:
- Payroll: This essential expense includes costs associated with paying your employees’ salaries or wages, benefits and payroll taxes.
- Insurance: Business insurance coverage is vital to protect your business assets, property and employees from unexpected events, accidents or other legal disputes. These expenses include liability insurance, workers' compensation, property insurance and other coverage. You’ll want to adjust your small business insurance coverage periodically to match the current value of your business and its assets.
- Licenses, Permits and Taxes: You need the necessary licenses and permits to legally operate your business and will be paying federal, state and local taxes. Failure to address these expenses can lead to legal issues, fines and potential disruptions to your operations.
- Rent//Utilities: Managing rent and utility expenses efficiently is important for maintaining a productive work environment and supporting your business's daily functions.
- Equipment: The right equipment, including machinery, computers, vehicles or any other assets needed to run your business, is vital for your startup to function effectively. Proper maintenance and investments in technology can boost efficiency, productivity and the quality of your products or services.
- Inventory: Maintaining appropriate inventory levels is critical to meet customer demand and avoid overstocking, which can tie up valuable capital. Effective inventory management is essential for cost control and cash flow.
- Advertising/Website: Marketing and an online presence are key to attracting customers and generating revenue. Effective advertising and a professional website can help your startup gain visibility, reach your target audience and establish credibility in the market.
Research Small Business Funding Options
Choosing the right funding option for your startup depends on your specific needs, the stage of your business and your financial situation. Debt funding and equity funding are two distinct methods of raising capital as a startup business. Capital refers to financial resources, assets and wealth — typically in the form of cash, equipment, property or investments. It serves as the foundation for your business to operate and expand.
Debt Funding
Debt funding involves borrowing money that needs to be repaid with interest while maintaining ownership and control of the business. Carefully evaluate the terms, interest rates and repayment schedules of each option to align with your business's goals and objectives. A few common debt funding financing options, including small business loans, are listed below:
- Small business loans provide immediate capital for various startup needs, while grants offer non-repayable funds, which can be particularly helpful to avoid incurring debt specific projects or initiatives.
- Equipment loans allow startups to acquire necessary equipment without depleting their working capital. It's an efficient way to spread the cost of equipment over time.
- Real estate construction loans are essential for startups involved in real estate development or construction projects; they provide the necessary funds to complete building or renovation work.
- The Small Business Administration (SBA) offers various loan programs for startups with many advantages. They are an attractive option for startups seeking financing while benefiting from government-backed security.
- Working capital loans help startups manage their cash flow and ensure that they have sufficient working capital to sustain their daily operations, especially during seasonal fluctuations.
- Small business grants are funds provided by government agencies, private organizations or foundations that do not require repayment. They can be used to support research, development or community-focused projects that align with the grant’s goals.
- A business line of credit provides a safety net for startups. It’s a flexible form of financing that allows you to borrow funds up to a certain limit. Interest is only paid on the amount borrowed, and you can withdraw and repay funds as needed.
Equity Funding
Equity funding is a method of selling ownership stakes in the company to investors. The choice between debt and equity financing depends on multiple factors, including your business's financial health, growth and preferences of both you as the business owner and potential investors. Below is a quick breakdown of common equity funding options:
- Angel investors are high-net-worth individuals who provide capital to startups in exchange for equity ownership. Often they offer not only funding but also mentorship, guidance and business connections.
- Family and friends who believe in your business idea may be willing to invest when traditional funding is not an option.
- Bootstrapping is using your personal savings and revenue generated by your business to grow. You maintain full ownership and control.
- Crowdfunding can provide you with capital while also testing market interest and building your customer base. There are various platforms like Kickstarter and GoFundMe that can help you raise funds.
- Accelerators offer startups funding, mentorship, resources and access to a network of investors in exchange for the equity to grow quickly.
- Incubators are organizations or programs that provide startups with resources, mentorship and support, often in exchange for equity. Unlike accelerators, incubators offer more flexible timeframes for growth.
- Business partners can bring expertise and resources to the table, making it easier to start and grow a business. They may co-own the business and share in its profits and losses.
Make Your Startup Business Attractive to Investors and Lenders
To help get the necessary funding from investors or lenders, focus on crafting a compelling business plan and building a strong credit score. A well-structured plan serves as your roadmap, showcasing your potential and outlining your growth strategy. It's crucial to back your claims with market research, demonstrating a deep understanding of your industry, target market and competitive landscape. Clear financial projections, including income statements, cash flow forecasts and balance sheets, should be included to show your financial strategy and profitability.
Building a strong credit score enhances your appeal to lenders and investors since it serves as a reliable indicator of creditworthiness. To improve your credit score, separate personal and business finances by opening a dedicated business bank account and getting a business credit card. Timely payment of bills, loans and debts is crucial to demonstrate your financial responsibility and reliability. Regularly monitor your business credit report for inaccuracies or errors and rectify them to maintain an accurate credit history. When seeking loans or lines of credit, borrow only what you need and can repay. Diversifying your credit by using a mix of credit types, such as loans and credit cards, demonstrates your ability to manage multiple forms of credit.
Create a Diverse Small Business Funding Strategy
Diversification is a powerful risk management approach. With a diverse funding strategy, you can better navigate such potential challenges as securing adequate funding or navigating a competitive marketplace. This helps protect your business's creditworthiness and maintain your operations.
It also provides you with flexibility to adapt to changing circumstances. Equity financing, such as investments from angel investors or venture capitalists, might be ideal if you’re launching a new product or entering a new market, while a business line of credit may be more suitable for managing short-term cash flow fluctuations. With a diverse funding strategy, you can choose the financing option that best aligns with your startup business.
By incorporating long-term financing into your funding strategy, such as term loans or equity partnerships, you show your commitment to business stability and growth. This long-term outlook can be particularly appealing to investors who look for opportunities with the potential for returns. It also signals your confidence in your business's ability to generate consistent revenue and meet financial obligations.
A diverse funding strategy allows you to align your financing with your business's strategic objectives. For example, when planning to expand into new markets or launch innovative products, you may need substantial capital. At this stage, equity funding, where investors provide funds in exchange for a share of the company, can be a valuable resource. Conversely, during periods of market stability and operational consistency, you may prioritize repaying loans and reducing debt.
One size does not fit all when it comes to funding. Evaluate your financial needs and opportunities to decide which funding options are most appropriate for your startup.
Take Precautions When Funding a Startup
While securing funding is critical for your startup, make sure you’re aware of various precautions to navigate this process effectively. A few tips:
- Routinely review your financial statements, cash flow and expenses. This helps you identify potential issues early and make informed decisions to manage your funds efficiently. Be prepared to adapt your budget and financial plan as your business evolves.
- Build a strong team. Your team not only boosts your chances of success but also enhances your credibility in the eyes of investors and lenders.
- Beware of excessive debt. It's important to strike a balance between debt and equity financing and to ensure that your debt obligations are manageable.
- Understand the terms and conditions associated with investments and how they may impact your decision-making authority. Choose investors who align with your vision and values.
- Create contingency plans to address potential setbacks, such as changes in the market, economic downturns or unexpected expenses. Having a well-thought-out backup plan demonstrates to investors and lenders that you are prepared for these scenarios.
- Maintain transparency with your investors and lenders. Keep them informed about the company's progress, financial performance and any significant developments.
By staying vigilant in monitoring your finances, building a strong team, managing debt responsibly, understanding equity implications, planning for contingencies and maintaining transparency, you'll be better prepared to navigate funding your startup.
Find a Local Commercial Banker
Consult with your local commercial banker about what small business financing options are right for your startup. Meeting with a trusted banker is essential when funding your business because they provide expert financial guidance, streamline the funding process, help secure the right financial services and offer ongoing support, ultimately increasing the likelihood of obtaining the necessary capital while minimizing financial risks. Contact our Northwest Bank commercial banking team today to learn more about how Northwest Bank can help your small business get funding and help protect your assets.
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