4 Ways to Fund Your Small-Business Growth
March 24, 2016 | Business and Careers
By Sonya Stinson
Less than two years after Shawn Daniel and Brandon McClure, both 32, opened Headquarters Barbershop in Ohio’s Dayton Mall, social-media buzz and a steady flow of walk-in traffic had created such brisk business that they were turning customers away.
With their 11 barbers’ booths fully booked every day, the business partners, who met in high school, decided to open a second location in another mall. They pooled money from business profits by maxing out their credit cards and from family and friends to finance the expansion. But when they got the contractor’s bid for building out the space, they realized they had under-budgeted that cost by more than 50 percent, Daniel said. They ended up filling the shortage with a loan from an online business finance company.
When your small business is ready to get bigger, funding that growth can be a challenge. Success depends on doing a thorough assessment of how much profit your company is earning, how much capital it needs to get to the next level and which potential funding sources—bank loans, venture capital investments or your own pockets—are most viable for your situation.
Here’s a look at four popular financing sources and some of the issues to consider when choosing the one that’s right for your growing business.
1. Family, friends and you. Zev Asch, adjunct professor of marketing at the Touro Graduate School of Business in New York City, thinks the ideal financing model is one that doesn’t require taking on debt. Because the future profitability of your business is never certain, there will always be a risk that you’ll run into trouble repaying the debt. At the very least, he said, the funds should include some of your own money and whatever else you can acquire from family and friends.
“If you are a smart entrepreneur, and you’ve been able to put money away—and have your own cash reserves in addition to the company’s,” Asch said, you may be able to finance most or all of the expansion yourself.
2. Traditional loans. A conventional business loan is another option with, of course, the best rates available to companies that have solid track records.
“What works in our favor today is that interest rates are still the lowest they’ve been in many years,” Asch said.
But beware of loans with balloon payments. Although the lower interest charged at the beginning of the repayment term for this type of loan “makes the initial phase of the financing quite comfortable,” Asch said, it only postpones the pain. Financial planning is much easier when each month’s loan payment is clear and consistent.
You may also want to consider the Small Business Association’s guaranteed loan programs, which have helped expand access to capital for many small business owners. Banks, credit unions and other lending institutions actually make SBA loans, but the agency’s backing helps increase the chances of approval by lowering the lenders’ risk.
3. Equity investors. If you have a high-growth business but lack the collateral that conventional lenders often require, you might consider pursuing investments from venture capitalists. Instead of making a loan, these investors trade cash for equity in the business.
“It’s not debt, but you’re giving up a piece of the company,” Asch said.
For that reason, it’s especially important to ensure that the business philosophy and goals of any investor you bring in are aligned with your own.
“If I’m okay with a monthly conference call with my investors in which they ask detailed questions about line items on the P&L,” Asch said, “then it’s okay. But if I’ve built a business and I’m looking for an investment without interference,” then a hands-on investor may not be a good fit.
4. Online alternative lenders. In the first half of 2014, nearly one in five small-business loan applicants applied to an online lender, according to the Joint Small Business Credit Survey, 2014, by the Federal Reserve Banks of New York, Atlanta, Cleveland and Philadelphia.
Daniel and McClure initially applied for a bank loan, but when their contractor came back with the specs that blew their budget, their application was denied. Daniel believes the business’s short history also worked against them. Deciding they would seek an alternative loan, they Googled “small business lenders” and applied to several that came up as results. They succeeded with one online lender, getting approval in just two days.
That speed of access is one of the biggest appeals of alternative business loans. But there are drawbacks. Interest rates for these loans can be substantially higher than those of SBA-guaranteed loans and other offerings from conventional lenders, as noted by Creditcards.com. Also, online lending sites don’t always make it easy to see the effective annual percentage rates lenders are charging.
Do your due diligence by checking out the lending company’s background. Find out if the company is accredited by the Better Business Bureau and whether there are any online reviews or complaints. And if the interest rate and fees the lender will charge are unclear, ask for a thorough explanation before you sign a loan agreement.
More Heads for Headquarters
Daniel and McClure opened their second barbershop in September in The Mall at Fairfield Commons. They say the new shop has been well received so far, and they hope some of the upgrades underway at the mall—like new restaurants—will draw even more customers.
The business partners said they are wiser now following their earlier budgeting mistakes and are looking forward to seeing their profits grow along with their space.
“We learned that when people said growth is cash-intensive, they were not lying,” Daniel said.
Sonya Stinson is a writer for print and web publications, businesses and nonprofit organizations. She writes about higher education, careers, small business, retirement and personal finance.
Originally published on Northwestern MutualVoice on Forbes.com.