The ins and outs of business funding

Around 66% of small businesses experience financial challenges, and close to half claim their most pressing issue is having enough money to cover operational costs. The solution? Knowing how to raise capital.

It’s important to understand how to raise additional business capital to always have enough to cover expenses and invest in growth. While traditional bank loans are a great start, there are several sources of funding you can tap into.

woman managing business funding

Understanding how business funding works

Business funding gives companies access to more money, which they can use to make purchases, fund business activities, or invest in growth.

Business owners usually get funding as cash that they can use to meet business needs. But, depending on the source of the funds, they might have to use the money in a certain way—such as buying a piece of machinery or spending the money on a certain business initiative.

Small businesses use funding for different purposes, but the main goal is to continue and improve operations.

For example, if the business is struggling to stay afloat—like to pay rent or employee wages—then funding goes toward getting the company on its feet again and maintaining sustainable operations. But if the business is performing well, funding can take it to the next level.

If your business is already stable, you might use funding to drive growth by:

  • Improving current products or services
  • Developing new products or services
  • Hiring more talent
  • Buying more equipment
  • Opening a new office

While small businesses and startups will almost certainly need business financing at some point, any company no matter the size can also utilize these types of opportunities, which may lead to extra capital.

So whether you’re a solo entrepreneur with your own business, a small enterprise with a handful of employees, or a private corporation that makes a few million dollars in revenue, business funding can help you.

An example of business funding

Let’s look at an example of the power of business funding in action.

Cisco, a company that makes network and internet products, started as a small business in the early 1980s. But in 1988, a venture capitalist noticed the company’s progressing performance and agreed to give the owners $224 million in funding.

Cisco used this money to grow the business—and today, it brings in more than $51.9 billion in revenue. This illustrates how funding can be the pivot point between going from a small startup to a multi-billion dollar company.

But where do you get funding?

Small business owners and larger corporations rely on various funding sources—such as crowdfunding, loans and grants, lines of credit, and investors.

Why small to medium businesses may seek funding opportunities

Funding can be game-changing for any existing business or aspiring entrepreneur dreaming of expanding or starting a business. And while eligible businesses can use their small business financing for virtually any purpose, here are a few main reasons that businesses most often seek funding opportunities:

Reason #1: Increase their working capital

Working capital is key to sound financial health for any business: It’s the amount of money or assets you have to keep your business operational and meet short-term financial obligations. Without enough working capital, you could run into money trouble.

You might decide to use small business funding to increase your working capital. For example, during a market downturn or a slow season, you could find yourself in need of an influx of cash to comfortably pay all your bills until business picks up again.

Reason #2: Purchase new assets or equipment

Your small business might have increased demand, but meeting this demand without new assets or equipment can be difficult.

Businesses sometimes postpone growth because they don’t have enough money to buy key assets. This could mean a new production machine, IT equipment, or even a new location.

Funding provides the necessary cash flow and allows your business to make the leap into a new phase of growth.

Reason #3: Make their startup operational

Entrepreneurs might have great ideas that could contribute to economic development, but they all need funds to take their ideas off the ground and make their startup businesses operational.

Many entrepreneurs look for funds to bring their ideas to life—they might use the money for buying inventory, hiring staff, or promoting their new businesses.

Funding allows these startups to create their products or services and begin their growth journey.

Reason #4: Growth financing

Growth financing can help businesses bring their business plan and vision to life, accelerating their success and ensuring a more profitable future.

For example, an existing business might have working capital but not have the extra money to fund growth activities.

To solve this, that business can raise funds to increase its sales team, develop new products or services, move into a new office, hire additional staff, or even expand internationally.

Reason #5: Debt restructuring

Small businesses could be juggling large amounts of debt to finance their operations. But at some point, the debt becomes too much to stay afloat.

Small business owners can use funding to consolidate their debt and reduce the number of monthly payments. This funding frees up cash that your business can use for other things.

The most common types of business funding opportunities

There is a funding opportunity to meet any of your business needs, no matter your growth stage. But before you set out to apply for any type of funding, it’s essential to understand your options, their purpose, and what each route can help you achieve.

Ultimately, you should choose funding opportunities that align with your business needs and goals. If you’re going to use your time and energy to get funding, you should have a clear purpose as to why and how you’re seeking the money.

Let’s look at the most common types of funding opportunities and how they can help you achieve your business goals.

Type #1: Use your own money

Starting a business from scratch with your own money might seem unrealistic—but 77% of small businesses fund themselves through either personal savings or financing. With the right approach and strategy, you can go far with self-funding.

The good news? Raising your own money has a positive impact on growth. It also allows owners to retain greater control over the company, its strategy, and decision-making. The global company, GitHub, started out with the owner’s funds until Microsoft bought it in 2008 for $7.5 billion.

But before you empty your savings account and invest all your money in your new business, let’s look at how you can use your own money to make your startup operational.

Bootstrapping

Bootstrapping allows business owners to use their own money or money from friends and family to fund operations. It’s one of the most popular funding methods for starting a new business from scratch and funding it until you qualify for external financing.

Bootstrapping works like this: You use your own money to fund only the most essential operations. For example, you might pay for a new company website, buy inventory, and hire part-time staff but hold off on renting office space until you can bring in enough revenue for such a large monthly payment.

When you invest your own savings, it signals to potential investors that you believe in your own idea and are willing to immerse yourself in it completely. You also retain complete control over the company and are not accountable to anyone for your decisions.

Additionally, you can ask your friends and family for money and add it on top of your own to grow a bit faster than you would with just your own funds.

But the downside is that you are accountable to the friends and family that give you money. Depending on your relationship with these early supporters, you could find yourself with a panel of critics you didn’t sign up for.

Another thing to keep in mind is that your friends and family might not be the savviest of investors—so you want to have an honest discussion with anyone willing to fund your business and make sure they understand there’s risk involved, no matter how sound your business plan might be.

Crowdfunding

Did you know that the popular virtual reality headset, the Oculus Rift, raised more than $2.4 million in donations from complete strangers? The company now has one of the most successful crowdfunding stories of all time—and continues to be a hugely profitable business.

Crowdfunding allows small businesses to raise money from people who find the idea interesting and innovative. The people giving you money offer them as donations, so they do not get company shares. This means that you still retain complete control of your company’s strategy while getting all the benefits of funding.

But with these donations, you are typically expected to reward the funders through a “gift,” which could include a prototype of your product, a meeting with you, or special shout-outs to thank them.

To start a crowdfunding campaign, you can use websites such as Kickstarter, Indiegogo, GoFundMe, and Patreon. Create an appealing description and visuals for your business and include what the gift is for anyone who chooses to donate money.

You can raise a significant amount of capital from crowdfunding without taking on any debt. This is a good option for increasing your working capital to keep your business running until you become profitable.

Type #2: Loans and grants

You can use multiple funding opportunities to launch your business, such as bootstrapping with your own funds and raising money through crowdfunding.

But once you’ve established your startup, loans and small business grants could be the next step.

Small business loans

A small business bank loan provides businesses funding in cash. Business owners need to pay back the loan with an interest rate for a specified time.

Whole Foods, the now-nationwide grocery store, is a great example of a loan success story: This store started as a small health shop in Austin, Texas, in 1978. After a few years, the owner, John Mackey, got a $10,000 loan to scale the business, helping him transform his small company into the grocery giant it is today.

Small business loans work the same way as any other type of loan. As a business owner, you apply for a certain amount of money to borrow from a bank or a Small Business Administration (SBA) approved lender.

But getting these loans takes time: Banks and the SBA-approved lenders want to make sure that your business can repay the business loan, so they have a team of people to go through loan applications and ensure the businesses they lend money to won’t have a problem repaying.

Therefore, there are some things you’ll want to keep in mind before applying for a loan:

  • It’s not always easy to qualify for a business loan as a startup. Businesses with 5+ years of experience have an easier time getting a loan—because, with a track record of profits, lenders are more likely to approve an application.
  • Paying back the loan with interest can impact your financial well-being. So before you apply for bank loans or Small Business Administration loans, make sure your business has the financial strength to qualify and handle the repayments. You also want to choose a loan with interest rates you can afford.
  • You’ll have to prove yourself. You’ll need a clean credit history, financial projections showing that you’ll be able to repay the loan, and other documentation demonstrating that your business makes a profit or will profit with the loan.

If you’re not sure how to get started applying for a loan, you can get help and learn how to write an effective business plan that can get you funding at a local small business development center (which you can find through the SBA website) or for loans through Score.org.

Business grants

A small business grant is often considered “free money.” Institutions, government agencies, global corporations, and technology incubators offer small businesses money or assets that can help them meet specific business goals or simply thrive as a growing startup. Unlike a loan, you do not have to pay it back when you’re awarded a grant.

There are four major areas that interested business owners can consider when applying for a grant:

  • Private business grants: Private business grants are offered by private corporations, companies, and businesses that want to help startups succeed. In many cases, you may work with a mentor to help you create a strategy for spending the grant money. You’ll likely have to submit regular reports on how you’ve spent the money and demonstrate its effect on your business.
  • Federal business grants: Government grants aim to promote economic growth and entrepreneurship in the country. Different federal government agencies and grant programs open up opportunities periodically—usually once or twice a year—for new and existing businesses to apply.
  • State business grants: State and local governments also provide funding programs for businesses within that specific region to encourage entrepreneurship and economic development. These grants work the same way as federal grants, with various states and local resources publishing calls for grant applications.
  • Small business grants for underrepresented communities: Small business grants are also available specifically for underrepresented communities, such as women-owned businesses, veteran-owned businesses, and minority-owned businesses. You can find these grants at various centers supporting minorities, such as women’s business centers, veterans’ centers, and other minority agencies.

Grantors usually send out a call for applications, and any eligible businesses can apply within that specific period. After a few evaluation rounds—including reviewing business plans and meeting with applicants—grantors decide which applicants to grant the money to.

You can check out Grants.gov, GrantWatch.com, your state’s government website, and other national agencies and organizations like Fast Break for Small Businesses and Minority Business Development Agency Centers for grant opportunities.

Breaking down the difference between loans vs. grants

We’ve covered both loans and grants, but here’s what you need to know about choosing between these two common paths:

Grants are taxable. The Internal Revenue Service (IRS) considers small business grants as business income. Because of this, you will have to work with your accountant to declare the money and pay taxes on it. Bank loans are not taxable by any government agency.

  1. Loans require interest payments. A traditional bank loan requires you to pay back the sum borrowed and interest. Depending on the type of loan you get, your interest may be between 2% and 100%. Grants do not have an interest rate and are completely free.
  2. Grants don’t contribute to building your business credit history. Businesses need to get credit to build credit—but small business grants are not considered credit, so they don’t impact your credit history.
  3. Grants are competitive. Any business that meets the eligibility criteria of a grant can apply for it. Even if you spend time and money researching grants and applying for them, there’s no guarantee that you will win any. Banks give loans without considering outside competition and only look at your business’ condition and finances.
  4. Loans have consequences. Your small business must make enough money to pay the interest charges and principal—and if you miss a payment, you could incur late fees or an increase in your interest rate. If you cannot pay the loan back, you’ll have to default on the loan. Luckily, you don’t have to worry about defaulting with grant money because you don’t have to pay it back.

Type #3: Funding from financial institutions

Financial institutions and alternative lenders offer numerous funding opportunities for existing businesses beyond traditional loans.

These funding opportunities are shorter-term, meaning they can help your business get out of a tough spot or afford small equipment purchases when you don’t have the available capital.

For example, credit lines and merchant cash advance providers can approve your application in less than 24 hours, so they are optimal funding solutions when you need cash but don’t have time to apply for a business loan.

Let’s dive deeper into funding from financial institutions so you can evaluate if these are the right choice for your small business.

Lines of credit

A business line of credit is an excellent option for ensuring you have available cash whenever you need it.

You can easily apply for a line of credit with any bank or alternative lender, and all you need is your business financials. If approved, you will get a card similar to a regular credit card.

Your credit line card has a limit, and you can use it to buy inventory or machinery, cover operating expenses, pay for repairs, or other purposes. You pay a monthly installment with a certain interest rate, and as you repay what you borrowed, the financial institution replenishes the funds available on your card.

Let’s say you want to buy inventory for $5,000. You apply for a line of credit and get approval for a $10,000 limit. You spend the $5,000 and then pay back whatever you can in the next few months. If you pay back $2,500, your available credit line is now $7,500.

If you have a stable business and cash flow, you can get an unsecured line of credit, which means you don’t need any collateral. But if you need larger amounts of cash, financial institutions will only issue a line of credit with collateral.

You can use your personal and business assets as collateral—but remember that you might lose them if you can’t pay back the amount you borrowed.

Merchant cash advances

Merchant cash advances (MCAs) are a convenient yet expensive way of raising capital. A lender gives you a certain amount of funds as a lump sum, and you pay it back with a percentage of your credit or debit card sales plus interest.

For example, if you get $20,000 as a merchant cash advance, then every day, the lender will take a percentage of your card sales. The terms can be different, but a lender will take around 20% to 50% of your daily sales until the entire advance is paid back.

While merchant cash advances are a quick way to raise capital, the interest rates are usually high—and can even reach 350%. Having to pay a lot in interest could hurt your business in the long run. Because of the expense attached to this type of funding, MCAs should be a last resort for getting a small business loan.

Invoice financing

Many small businesses with a longer sales cycle have cash flow issues because customers take their time paying invoices.

As such, businesses end up with large amounts in their accounts receivable on their balance sheet, which is the cash you expect from your customers who have already bought products or services. Sometimes, accounts receivable may become so large that your business runs out of cash to finance daily operations.

Invoice financing, otherwise known as factoring, is another method for raising capital to help you cover your daily expenses.

A lender gives you the money to cover accounts receivable to run your business while waiting for your customers to pay you. When customers pay you, that money goes to repaying your invoice financing.

Invoice financing is a great help for many small businesses because you get the cash to create or work on new projects while waiting for previous customers to pay you. The downside is that customers might default on their invoices, rendering you unable to pay back the invoice financing.

Type #4: Investors

Another avenue for raising capital that small business owners can use is investments. Owners willing to sacrifice a percentage of their company for capital use this method to scale their businesses and set themselves up for long-term growth.

Raising capital from investors is incredibly popular amongst startups and small businesses, and there is no shortage of success stories. WhatsApp, the popular Meta app, was initially a standalone company. A group of investors put $60 million into the company so it could grow into the giant it is today, with more than 2 billion users.

Here are the different ways a small business owner can take advantage of raising capital through investors.

Venture capital funding

A venture capitalist provides capital to small businesses in exchange for ownership shares and a decision-making role.

Business owners can pitch their business ideas or existing businesses to a venture capitalist or a company. If venture capitalists think there is potential for high returns, they will fund your venture.

Venture capital funding is a great way to raise money if you need a large influx of cash to scale, but you should be prepared to give up a portion of the company and some control over strategy and decision-making.

Partner financing

You might have a business idea that’s so innovative that prominent players in your industry admire it and want to be a part of it. That’s where partner financing comes in!

A large company will invest and help your small company raise capital in exchange for equity or royalty-based perks. Perks could include special access to your products or services, staff skills, or distribution network.

In return, you also get perks because you can use their marketing programs and will have access to the company’s salespeople, high-profile customers, and other resources.

Partner financing is an often-overlooked alternative to venture capital, but it’s worth exploring. You could partner with a company that will have experience in your industry and could take your business to the next level.

Angel investors

Many business owners think angel investors and venture capitalists are the same, but there is one difference: Angel investors provide capital to businesses with a lot of growth potential but are too small or too early in their journey to attract venture capital funding.

Angel investors get heavily involved in running the business they invest in, providing their knowledge, expertise, and network to benefit the business. They are personally invested in ensuring the company succeeds so that they don’t lose their funds.

Small business owners who want to raise capital through angel investors have to be prepared to give up a large portion of control to the investor—but they benefit from sustained support in the long run.

Convertible debt

After raising your own funds or taking out a loan, your small business might need additional capital. But because you have a lot of debt, lenders may not want to give you more money, whether a line of credit or a merchant cash advance. So, what can you do?

You can work with an investor or group of investors and get convertible debt funding.

Convertible debt is when your business takes money from investors, and that debt amount will turn into equity for the investors.

Let’s say your small business is worth $10 million, but you have $2 million in debt. An investor could give you $2 million to pay back your debts, so you can free up cash flow to scale your operations. But the investor now owns $2 million of your company, which equates to around 20%.

The advantage of convertible debt is that you have enough cash flow to grow, but you have to be willing to lose some control over your business and bring in a new partner—which will ultimately affect strategy and decision-making.

How to apply for the right funding opportunity

Understanding how you can raise capital is one thing. Applying for funding opportunities is another.

With so many new businesses starting every day, there is a lot of competition for a limited amount of funds. Standing out from the crowd is critical.

To help your business attract funding, you can follow a step-by-step approach to help your business put its best foot forward, whether you’re applying for a loan, a grant, or pitching to investors.

Step #1: Decide your funding amount and resources

While there are endless opportunities out there, you, unfortunately, can’t apply to all of them—not all at once, anyway. So you have to prioritize the sources that seem the best fit for you.

If you have a minority-owned business, apply for grants targeted to your minority group. If you have a product that would help solve a major governmental or societal issue, then federal grants are for you.

Being selective with your funding sources can identify where you have the highest probability of winning and getting the business funding you need.

Once you make a list of the opportunities you will apply for, decide how much funding you need. Your funding amount must be reasonable and at least partially cover what you need to make your business operational.

Step #2: Analyze the application and selection criteria

Every funding opportunity has its own application process and eligibility criteria. Carefully analyze every requirement to verify whether you meet it or not. Applying haphazardly to every opportunity will waste your time, so you should only apply for those you qualify for.

For example, the Small Business Innovation Research (SBIR) and Small Business Technology Transfer (STTR) programs offer grant money to businesses whose goal is to conduct research and development.

If—after you’ve read the rules of a funding opportunity—there are still a few things you don’t understand, send out questions to the responsible funding agency to get answers. You should have the most comprehensive information possible to help you decide what to apply for.

You can also hire people who will help you with the application process for types of funding. Specialized grant writers, for example, can write all of your grant statements on your behalf—but keep in mind that you have to pay them even though success isn’t guaranteed.

Step #3: Create and collect the necessary documents

Supporting your case is key to getting funding. You can make your application stronger by demonstrating your business performance, future goals, and how you plan to spend the funding.

Depending on the type of funding you’re applying for, you will need to submit supporting documents.

For loan applications, you will need documents that relate to your:

  • Your credit report
  • Business plan
  • Financial projections
  • Financial statements
  • Bank statements
  • Business registration

For grants, you will need:

  • Grant application forms with all questions answered
  • Important written documents, such as:
  • History of your business
  • Mission and vision statements
  • Project description
  • Cover letter
  • Business plan
  • Financial projections
  • Business registration documents

And for venture capitalists or angel investors, you must have:

  • Pitch deck
  • Business plan
  • Financial projections
  • Demo of your service or a mock-up of your product

Step #4: Submit your application before the deadline

There are funding opportunities, such as loans, lines of credit, or merchant cash advances, for which you can apply at any time. But all grants have hard deadlines, and you must submit your application before that deadline to be considered.

Even if your application is perfect, grant programs can reject your business if you submit the application even an hour later than the specified time. If you miss the deadline, you will have to wait until the next round of applications, which could be next year.

So be diligent: If you’re applying for a grant, submit your application earlier rather than later.

Step #5: Track each application

If you’re applying to multiple funding opportunities, you should keep track of their status.

Loan officers might ask for additional documents, and venture capitalists can call you for additional rounds of pitching or negotiations.

Staying on top of every opportunity will help you ensure you’re meeting every requirement and maximizing your chances of getting funding.

Step #6: Celebrate your wins

You win some, and you lose some. If one of your funding applications was approved, celebrate! You can now use that funding to help your business grow.

If you didn’t win a funding application, don’t fret. Instead, analyze the feedback you got—or even better, reach out to evaluators and agencies to see what you could have done better. The feedback will be beneficial for the next time you apply!

Easily track your funding progress with Divvy

Business capital is something every startup and small business needs, and one of the best ways to get it is through funding. Regardless of the industry you’re in and the type of business you’re running, there is no shortage of opportunities available to help meet your business goals.

From self-funding, Small Business Administration loans, and grants to venture capital, you have the flexibility to choose the type of funding that works best for you. But no matter which opportunity you’re applying for, you need to have comprehensive financial statements ready and available.

To help you keep all your financial ducks in a row, Divvy offers an easy-to-use and powerful spend management platform that streamlines the process of tracking your expenses and budgets.
Get instant visibility into every dollar you spend and be better prepared for your next funding opportunity. Learn more and see Divvy in action today.

The information provided on this page does not, and is not intended to constitute legal or financial advice and is for general informational purposes only. The content is provided “as-is”; no representations are made that the content is error free.

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