Sooner or later, most small businesses find they need financing, whether to fuel growth or resolve a cash flow gap. When deciding which funding avenue might be right for your business, it can be helpful to become familiar with options besides traditional bank loans. Some financing avenues you can consider are outlined below, including:
- Loans from friends and family
- Credit cards
- Government loans
- Alternative or online loans
Loans from Friends and Family
A popular avenue for obtaining funds is to get a loan from your family and close friends who may want to invest in your business. Before accepting loans from friends and family, consider the pros and cons.
Low Interest Rates
Because new businesses are unproven, financial institutions may charge a higher interest rate for small business loans. A potential benefit of borrowing money from friends and family (regardless of whether it’s to launch a new business or to support an existing one) is that they may offer a lower interest rate than a conventional bank.
Friends and family may be more flexible if a repayment is delayed, which a traditional bank usually won’t allow without a fee.
In general, friends and family probably won’t evaluate your business in the same way a bank will.
By accepting a loan from family and friends, you may be opening up your personal finances as well as how you run your business to scrutiny.
Going outside of a financial institution for business funding can complicate your tax situation if not properly handled. Accepting a loan from friends and family may be classified as a gift for tax purposes instead of being categorized as an investment. To protect everyone’s interests, it’s advisable to use a lawyer to make sure all agreements are in writing and terms for loans are clear.
In addition to tax issues that may occur with a “friends and family” loan, your loved ones may assume they have a right to interject their opinion about how the loan should be spent or how the daily operations should function. Working with a business attorney to write up the legal paperwork that outlines the terms and conditions of the loan can help alleviate any confusion.
Credit cards can be useful when used responsibly.
Important to know: Two types of rates associated with credit cards:
- Introductory Interest Rate — Credit card companies will often offer an introductory interest rate of 0 percent for a period of 12 to 18 months. This means you can purchase a new $10,000 piece of equipment for your new bakery and won’t have to pay any interest for a year or more. The downside is you may be hit with the entirety of the accumulated interest if you’re unable to pay the full balance within this promotional time frame.
- Cash Advance Rate — A cash advance from a credit card allows you to get quick access to funds. A big consideration to a credit card advance is that you’ll almost always have to pay a cash advance fee as well as upward of 24 percent interest on the amount borrowed. And usually, there isn’t a 30-day grace period on these advances like there is with regular credit card purchases.
In many cases, larger banks may opt to give small business owners large lines of credit with a credit card versus a business loan. As a result,, credit cards can offer higher approval rates for small business owners compared to other funding options.
Using credit cards to fund your business means you can purchase equipment, inventory, and office supplies as you deem necessary. Unlike a loan, you don’t have to take out a lump sum at once and pay interest. Instead, you can purchase as you need and pay interest on the funds you use rather than on the whole amount.
High Interest Rates
Business credit card interest rates can be close to three times the interest rate you’ll pay with an SBA loan. So, using a credit card to pay for large purchases that cannot be paid off within the 30-day grace period usually makes it an expensive loan.
If your business credit card is paid late, or if you’re carrying a high credit card balance, it can have a negative effect on your personal credit.
When not managed successfully, there’s a risk of going into debt when using credit cards to launch a business. The cost of credit card debt, and the interest associated with it, can eat away at a company’s profits.