Setting up a business requires money, but how should finding funding for small businesses take place? We have reviewed many articles we wrote in the past to help acquire loans and funds for small businesses – and we found out that most of them faced one major issue – they did not know how to secure these funds.
A recent study showed that over 94% of small businesses fail within the first year of its incorporation. The main challenge behind this was lack of capital or steady cash flow in hand.
While some of you may already have put in your savings into starting up or had some cash to bootstrap, a little extra money never hurts. If you are a small business, managing your money wisely can make or break the deal for you.
The most sure-fire way to get funding for your business is to apply for a business loan.
However, even now, many businesses still get confused about:
- Where to get money from?
- How much to borrow?
- What paperwork is involved? and,
- How to pay it all back and end up profitable?
So, before we discuss types of funding for small businesses, let us explore a few pre-requisites. Like this:
- 1 Do small businesses need loans?
- 2 When should small businesses apply for a loan?
- 2.1 What small businesses need to know before taking a loan:
- 2.2 Alternative sources of funding for small businesses:
Do small businesses need loans?
If you are thinking how to start a business, this is the most important question you need to ask yourself. Are you looking for capital to kick-start the business? Do you need a loan to stock up on supplies? Or are you on an expansion mode?
In a nutshell, a small business needs funding to:
- Handle cash flow shortages
- Grow an existing business
- Increase opportunities available in the market, where goods can be purchased at a reduced cost.
When should small businesses apply for a loan?
When it’s time to expand the business:
Businesses need to grow. You cannot stuff your employees in a cramped 1BHK forever. Studies show that banks tend to loan money to small businesses that are looking to buy property at some point to expand operations.
This proves to banks and other lending institutions that your business is doing well, gaining profits and has a positive cash flow. When you apply for a small business loan for buying or leasing property, it is given a mortgage. If you are headed for a long term goal, it is given for a duration of 25-30 years.
When it’s time to buy inventory & supplies:
This applies mostly to seasonal businesses. You could be a small business, but you will still have to buy raw materials or supplies to run. In case your business is seasonal, you will want to buy your inventory supplies well in advance to make enough sales once the orders are placed.
For this reason, you may need a bank or NBFC to provide you with a loan, especially if you need to purchase a large amount of inventory at that time. Such loans are generally short term loans and you will be able to pay them off once the season is over.
Working Capital requirements:
Every small business needs working capital. It is the money you use to manage your day-to-day operations.
Small businesses need loans for daily incoming expenses until earnings come in steadily to cover your working capital needs. Banks and lending institutions provide these short term loans to small businesses to enable them to kickstart in the market.
If you are just setting up a small business it is a good idea to get this loan, since it is easy to pay off. Your business can repay the loans once there is a positive cash flow coming in. Working capital loans tend to have a higher interest rate than, for example, real estate loans since banks consider them riskier.
What small businesses need to know before taking a loan:
Budget your expenses, your feasibility quotient for every plan and strategically cut costs where you do not need it immediately.
Is the loan urgent?
Do you need a business loan? Consider other options before you finally decide on a loan. Keeping some time before requiring a loan allows you to conduct groundwork. Once you’re sure you need a loan, check up on your credit score, search around for an ideal lender or re-analyze the amount you’ll need. Be prepared for a loan application.
Check your credit score:
Request a copy of your credit report from your bank before applying. Check your credit score to ensure you are viable for a loan. In case of any mistakes, you can approach the credit bureau or bank and rectify any errors. A good credit score helps you score a low-interest loan.
Documents to keep in hand when taking a loan:
If you do not carry all the documents required for your small business loan, there are high chances you could get rejected by the bank/ lending institute. Some of the important forms you need to keep handy while applying for a small business loan are:
- Application Form: Complete loan application form with one passport size photograph
- Identity Proof: Passport, Photo PAN card, Voter’s identity card, Driving license
- Residence Proof: Ration card/Telephone Bill/ Lease agreement/ Electricity Bill/ Passport/Trade license /Sales Tax certificate
- Age Proof documents: Passport, Photo PAN card, Voter’s identity card
- Financial Documents: Copies of income tax returns for the last two years along with the latest bank statements for 6 months and P&L and balance sheet for the last two years audited by a Chartered Accountant.
Alternative sources of funding for small businesses:
If you want to externally fund your business, there are some low-risk ways of making it happen. Thankfully, banks are not the only way to get funds coming into your business to keep it going.
Peer to Peer (P2P) investment:
If you know people in your own personal network or other similar businesses, you can borrow funds from them for your business – also known as P2P lending. While this is a common type of funding, it is also highly risky in case you find it difficult to pay back the loan on time. Ensure your investors know the risks involved and ask for only what your company needs.
Affluent individuals who willingly invest in businesses that are doing well for themselves. They agree to invest in companies that meet their own eligibility criteria. Angel investors invest in businesses, not just simply provide funding. Owing to their experience, they could participate in the management process as well.
Pitch your business plan to a plethora of online investors and they will pick you. Investments can be debt, equity or rewards-based. Do your homework before launching onto a crowdfunding platform. Check reviews and testimonials. Crowdfunding is a new way of funding for small businesses that have been gaining popularity. All you need to do is find a trustworthy crowd-funding
VC firms provide early-stage funding for small businesses and you can approach them if you are looking to borrow long term, large scale loans. VCs invest to control your company to an extent, so approach cautiously.
We understand that finding funds for your business can be a task that requires some knowledge upfront. so, we created a full course for you – for FREE! You can register for this course on mojoVersity – our e-learning platform made exclusively for small businesses.