Small business capital isn’t just necessary when you first start your business. The adage of needing to spend money to make money is also true as your business grows.
You need to secure small business capital to invest in the equipment, tools, and inventory required to produce goods or provide services. Small business capital is also necessary to pay for labour costs, expansion, and continued growth.
Fortunately, there are multiple ways to fund your business and secure small business capital. Which one you choose will depend on your specific preferences, situation, and needs.
Determine how much funding you’ll need
Before you secure capital for your small business, you need to determine how much funding you require. Your business plan should outline the costs of running your business at every stage, including:
- Registration, permit, and licensing fees
- Rent and lease payments
- Equipment, tool, and supply costs
- Inventory (both initial and ongoing)
- Material costs
- Marketing costs
- Labor costs
- Ongoing professional fees
After you calculate the total amount of funds your business requires, subtract your existing capital. The remaining number represents how much capital your business still needs to secure.
When you secure small business capital by taking on debt instead of offering equity, your business is funded via debt financing. Any type of agreement in which you borrow money, such as a business loan, line of credit, or personal loan, is considered debt financing.
Advantages of debt financing
Debt financing is effective for raising funds without giving away equity, or ownership, of your business. Instead, you’re responsible for repaying the loan in full, including interest. Once the loan is paid in full, your debt is repaid and the deal concludes without any long-term stipulations, terms, or expectations.
Additionally, interest and fees paid on a business loan are tax deductible in Canada.
Disadvantages of debt financing
In addition to paying interest on the money you borrow, securing small business capital through debt financing often requires you to put up collateral to secure the loan. If your business lacks sufficient collateral, you (as the business owner) may have to personally guarantee the loan.
In other words, if your business fails or is unable to pay the loan back, you are personally responsible for doing so, which may require you to sell your own property or investments, or dip into your personal savings.
Lenders also expect consistent and steady loan repayment regardless of your business income or cash flow. Even if your business has a slow period or there is an economic downturn, you must continue to repay your debt as agreed.
Equity financing is a method of raising small business capital by selling shares of your business. This is done by selling shares to individual investors or groups, such as your friends, family, venture capitalists, or angel investors. Equity financing may also be achieved by making an initial public offering (IPO) to sell shares on the market.
Advantages of equity financing
Unlike debt financing, equity financing provides funding for your small business without any repayment obligations. This means your business has immediate access to the funding needed to grow, pay existing obligations, and maintain ongoing operations.
Disadvantages of equity financing
To secure small business capital via equity financing, you exchange ownership shares of your company with investors. As a result, you may need to consult investors before you make major decisions.
Similarly, profits must be shared with investors, even if all they contributed is funding (and not advice, guidance, or other support).
Get venture capital from investors
Investors are people or groups that contribute venture capital (VC) in exchange for a financial return, which is typically a portion of ownership in your business and a share of profits.
To secure capital from VCs, your business often needs to show signs of expansion and growth on a long-term basis. This requires meticulous proof and planning that your small business is led by strong management in a solid market and with a competitive product offering.
However, securing small business capital from VCs comes with a bonus. Because VCs have a stake in your business, they often supplement their capital with advice, guidance, networking, and other assistance to help your business achieve its goals and continue to grow.
How to get venture capital funding
Before securing venture capital funding, you must find VCs willing to invest in your specific industry, type and age of your company, and geographical area. Once you identify a VC who’s a good fit for your company, you must develop an exciting and informative pitch and provide details about your business, including your business plan.
If your proposal interests a VC, they will perform due diligence to ensure the information you provided is accurate and your business meets their standards and expectations. From there, the VC will invest capital into your business through the structure it deems best, such as a SAFE.
Get a small business loan
Small business loans are one of the more basic means of securing small business capital. A small business loan may provide you with the capital necessary to improve your cash flow, purchase needed equipment or inventory, or expand your business into a new market or space.
However, like VCs, not all lenders are the same. Every bank, credit union, and financial institution has its own set of criteria you must meet to qualify for a small business loan, though qualification often requires satisfying the five “Cs” of lending:
- Character: leadership and management experience, skills, and track record
- Capacity: the ability to repay your loan balance, proven through your credit history, business plan, and financial documents
- Capital: liquidity, growth, profitably, and cash flow
- Conditions: the risk your business presents to the lender
- Collateral: what you offer to secure the loan
Use crowdfunding to fund your business
Crowdfunding is a means of securing small business capital via donations or investments made by the “crowd” through crowdfunding platforms. In exchange, the business may offer their backers rewards, such as:
- Gifts, merchandise, discounts, and other perks
- Equity (a portion of ownership in your company)
- Interest (if you relied on crowdfunding for a loan vs. donations)
- Gratitude (if the funds are considered a donation)
Using crowdfunding to secure small business capital comes with its own pros and cons, but given that $17.2 billion is raised annually via crowdfunding, it may be an effective means of funding your business—particularly if other methods are unavailable to you.
Funding from family and friends
Surveys show 22 per cent of new business owners rely on family and friends to secure small business capital within the first three months of starting a business. As with other types of funding, investments from family and friends may be structured as:
In any case, securing capital from family and friends may be one of the easiest avenues available to fund your business. However, you should remain professional about the arrangement to avoid compromising relationships with those closest to you.
Tapping into retirement accounts
Your retirement accounts may hold a tantalizing amount of funds that could be used to secure small business capital.
How you tap into your retirement accounts for business capital depends on the type of retirement account you have. For example, you may use distributions to fund your business, borrow against your account, or cash out your account entirely.
However, relying on your retirement accounts for business capital may not always be the best idea. Doing so may expose you to tax liabilities or penalties for early withdrawals depending on your age, the type of account, and how you tap into it.
Government grants and subsidies
Small business grants help businesses secure small business capital without requiring loan repayments or equity. However, small business grants are often restrictive and only awarded to businesses that fit the specifications of the grant, such as benefiting underserved communities or protecting and improving your local region.
Off-balance sheet financing
Off-balance sheet financing (OBSF) is a type of accounting practice in which certain assets and liabilities are not recorded on a business’s balance sheet to keep low debt-to-equity and leverage ratios.
Off-balance sheet financing is most often accomplished via minority stakes in other companies, partnerships, joint ventures, and operating leases.
This results in a balance sheet that looks more attractive to investors and lenders, helping you achieve more favourable financing and investing terms.
The bottom line
The best way to secure small business capital for your business depends on your specific needs, preferences, and requirements. Fortunately, no one choice is your only choice. In fact, the best way to secure capital for your small business may be to mix and match funding avenues, particularly at different stages of your business.
Even if you start by tapping into your savings and relying on gifts from friends and family, it’s wise to consider alternative methods of securing small business capital—especially if your business needs significant funding to reach the next level.