The Guide To Getting A Loan For Startups

By Meredith Wood of Fundera

In 2016, the Kauffman Foundation released a report stating that America was on the verge of an entrepreneurial explosion. Among other factors, the Foundation cites lowered barriers to entry (such as the increasing accessibility of digital technology), as well as an increase in tech-savvy, hungry Millennials reaching prime entrepreneurship age (their 30s and 40s) as reasons for optimism.

Clearly, tech is shifting our cultural paradigm of work and re-defining the work landscape. Even so, the difficulties of starting and running a business remain the same, especially where it concerns cash flow. By one estimate, nearly 82% of business failures in the United States are caused by poor cash management.

As a result, it’s crucial that businesses have enough money for operating costs such as staff payroll, inventory, advertising, and space. If you’re not sure where to get the money to get your business going, here are a few options to consider.

 

Small Business Administration Loans

The important thing to understand about the Small Business Administration, or SBA, is that it isn’t a lender, per se. It’s a government office that handles all aspects of small businesses, from advocacy to helping entrepreneurs understand and cope with regulation.

One of its goals is to widen the availability of capital by making a variety of loans accessible; however, instead of lending out its own capital, the SBA partners with private entities, underwriting the loan and reducing some of the risk. Therefore, if an entrepreneur can’t pay back the loan in full, the lender has some protection from a major loss.

The SBA’s umbrella of loans includes a wide variety of different programs, many of which have very specific requirements on what the capital can (and cannot) be used for. Take the popular 7(a) loan program, for which the SBA charges a small fee, and guarantees 85% of loans up to $150,000, and 75% on $150,000. Though it can be used for a wide range of business purposes, from paying operational expenses to purchasing business inventory, there is an equally long list of restrictions, including paying off delinquent taxes.

Yet another helpful class of SBA-backed loans is the CDC/504 program, which provides capital for real estate related purchases, such as renovating facilities, buying machinery and equipment, or buying land. This class of loan is especially helpful for startups seeking to expand their facilities, either to another state or simply to another location within the same area.

Given that the SBA has such a wide variety of programs for so many different purposes, it’s worth looking into their programs. It’s more likely than not that entrepreneurs will be able to find some loan program that suits their purposes.

 

Venture Capital

In the last quarter of 2016, venture capital (VC) investors were responsible for granting $12.7 billion to 1,736 startups. As a tried-and-true method of startup funding, VCs offer a simple deal: founders will approach the firms with their idea.  In exchange for providing capital and funding, VC investors will receive a share of equity, essentially partial ownership of the startup.

Still, VCs have their drawbacks. To be attractive to VC investors, startups must have the potential to be wildly successful. Obviously this factor isn’t always quantifiable, as an interview of six VC investors will yield six different answers, from relationships to research (or none at all).

Another important thing to note is that venture capital is a very short-term investment. As Harvard Business Review points out, VCs buy a stake in an idea, encourages growth and fosters profitability, and eventually exits after selling the startup to a major corporation. As a result, entrepreneurs who want to retain control over their companies may wish to steer clear of VCs, and bootstrap their startup instead.

 

Using A Credit Card

Funding your startup with a  credit card is a double-edged sword. While you, the startup founder, can stand to earn piles of perks, rewards, and good business (and personal) credit, you also stand to lose everything.

Take the example of Philip Lindblom, CEO and founder of 1000 designers, who got more than he asked for when he tried to bootstrap his startup using only credit cards. When revenue fell, Lindblom had to max them out one by one over a year’s time.

As such, he came face to face with the extremely unforgiving terms of credit cards, from the sky-high interest rates to the repossession clauses (personal and business property can be seized by credit card issuers as collateral).

Although Lindblom personally did manage to pay off his bills and turn 1000designers into a functioning, profitable startup, the key lesson is that entrepreneurs should not use their credit cards as a sole source of funding.

In specific circumstances, business credit cards can do a lot of good, especially if you need the funds for a quick purchase in a hurry.  

 

Revolving Line Of Credit

While this term can be a bit misleading (credit cards are also classified as being a revolving line of credit), here we refer specifically to flexible, fast lines of credit from web-based alternative lenders like Kabbage or BlueVine.

Like a credit card, entrepreneurs only have to repay what they use. For instance, if a founder borrows $5,000 to upgrade some computer hardware, he will only be liable for that amount. Further, if he splits up his loans ($5,000 yesterday, $10,000 next week), each amount is treated as a separate loan, to be paid back in its own time.

The biggest draw of revolving lines of credit offered by alternative lenders is the fast approval process. These lenders use algorithms to quickly check your credit, spending habits, and trends in order to assess creditworthiness and risk, automating the lengthy, troublesome underwriting process at traditional banks.

But alternative lenders have their drawbacks as well. In many cases, the payback term can short, and in almost all cases you can expect the rates to be quite high. Whether speed, convenience, and flexibility can overcome the issue of interest rates is a call that only you can make.

 

What Makes Sense For Your Situation?

The right business loan can be a lifeboat to success…while the wrong loan can sink your startup in murky waters. No matter what option you choose, always keep both the pros and cons of a business loan in mind. Create a financial forecast or hire a bookkeeper so that you have some real insight into your cashflow. That way, you can spot potential problems before they hit your bank account.

 

Meredith Wood is the Editor-in-Chief at Fundera, an online marketplace for small business loans. Prior to Fundera, Meredith was the CCO at Funding Gates. Meredith manages financing columns on Inc, Entrepreneur, HuffPo and more, and her advice can be seen on Yahoo!, Daily Worth, Fox Business, Amex OPEN, Intuit, the SBA and many more.

The views, opinions and positions expressed within this guest post are those of the authors alone and do not represent those of CBS Small Business Pulse or the CBS Corporation. The accuracy, completeness and validity of any statements made within this article are verified solely by the authors.

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