Managing cash flow in small businesses within their first year or so of operations can be extremely challenging. New businesses can often find themselves in between a rock and a hard place after paying bills, investing in inventory, and waiting for sales to realize revenue. So how exactly how do you secure a line of credit for your small business?
Dealing with shortages of funds on hand is no small matter, either; over 90 percent of small business failures can be attributed to poor cash flow. New businesses especially need a line of credit to ensure that cash flow problems remain manageable, and do not immediately force a young company into a life or death struggle each month.
Here are four ways that businesses can secure a line of credit, and ensure they have the cash reserves on hand to ensure financial challenges in their early days of operation.
Obtain Traditional Bank Credit
A conventional bank or other lending company is the most straightforward means for a small business to obtain a line of credit. A line of credit is essentially an open loan that a small business can draw from regularly – either to invest in new capital, make purchases, pay bills while awaiting sales to generate revenue, etc. – when it does not otherwise have the cash on hand for daily operations. Typically, banks only charge interest on the line of credit’s outstanding principal.
An established business may be able to obtain an unsecured line of credit, while a newer business that cannot demonstrate consistent revenue streams may be required to provide some sort of collateral. If you are a sole proprietor who has poor credit, or otherwise has had difficulty with loan repayments or paying bills on time in the recent past, it may be difficult to obtain a standard line of credit from a bank or other lending institution.
SBA 7(a) Loan Program
Another option for small businesses seeking to insulate themselves against cash flow problems in the early days is the Small Business Administration (SBA) 7(a) loan program. SBA 7(a) loans are designed to help entrepreneurs “establish a new business, or to assist in the acquisition, operation, or expansion of an existing business.” The SBA does not provide the loan itself, but rather guarantees it on behalf of the actual lending institution; this guarantee allows the lender to shoulder additional risks on new ventures, and to provide typically lower than average interest rates to the small business in question.
The SBA does not provide the loan itself, but rather guarantees it on behalf of the actual lending institution; this guarantee allows the lender to shoulder additional risks on new ventures, and to provide typically lower than average interest rates to the small business in question.
The maximum limit on an SBA 7(a) loan is $5 million, but businesses can request far less, depending on the size and scope of their operations. While a small business will still have to meet basic requirements to obtain a loan through the 7(a) program, startups may have more success through the 7(a) route than they otherwise would with a standard bank line of credit.
Many major banks offer these types of loans; if you are having trouble finding one in your area, you can also use the SBA’s search tool to locate one as well. While the bureaucracy of working with a bank and the SBA simultaneously may be a bit daunting, a line of credit is nonetheless a line of credit, so work with what you’ve got.
Seek Out Investors
If either your credit or your negligible business track record make obtaining any sort of bank line of credit an impossible task, there are still options. One of the tried and true ways to ensure that you have sufficient cash reserves on hand in a small business’s early days is by seeking out investors. There are many people and organizations with cash on hand that is willing to invest in small businesses; many entrepreneurs often turn to deep-pocketed friends or family members to do so.
The terms you can set with prospective investors, as well as the cash that they are willing to provide upfront, will likely depend upon your small business’s current financial straits and its potential to generate profits. Nonetheless, ensure you understand the terms and develop a written, legally binding agreement to whatever your investors and your company settle upon. This will protect both you as well as your investors in the long run.
Finally, ensure that you consult with your accountant prior to seeking out investors. Certain types of loans, especially those that are interest-free, may expose your business to additional tax liabilities in the short term.
A relatively new and innovative way to obtain funds for your business in the early days is through crowdfunding. Crowdfunding is simply the process of funding a venture by raising money through a (very large) group of investors. While people still conduct crowdfunding through advertisements and mail, the most popular means to do so today are via the Internet, on sites like Kickstarter and IndieGoGo.
Crowdfunding offers small businesses and entrepreneurs several advantages over banks and traditional investors. First, the aforementioned platforms can help to generate significant amounts of capital in a short amount of time. Additionally, a particularly imaginative or otherwise effective crowdfunding campaign may generate new customers, as well as cash; investors who are enthusiastic about your company’s new products or services may be the first ones lining up to buy them once the cash starts flowing.
However, an entrepreneur intending to raise money through crowdfunding will have to develop an effective pitch. If you intend to get a group of total strangers to invest in an unproven company, it better be good. As one highly successful entrepreneur put it, “if [the crowdfunding investors] don’t believe it will work, they won’t back it.”
No matter how hard you work, or how disciplined you are, your new business will not survive if it experiences serious cash flow problems early on. One of the best ways to insulate your company from cash flow issues is to obtain a line of credit. There are numerous options to do so, each with its own advantages and disadvantages.
As you prepare to embark on a new business venture, ensure you research all of them. You are ready to secure your cash flows, and your company’s viability, in the challenging days ahead.