Joseph is the CEO of SnapAds, which helps local businesses find, keep and reward customers.
Entrepreneurship can be a challenging yet fulfilling journey. Among the important decisions you’ll have to make as a business owner is how to finance your venture. With numerous financing options available, it’s crucial to determine the best fit for your unique circumstances and business type.
I have spent the last 20 years in the startup ecosystem, both as an investor and an entrepreneur. Having invested or raised hundreds of millions, I know how crucial it is to determine the best fit for your unique circumstances and business type.
Out of the over 33 million businesses in the United States, most fall into two main types: lifestyle or scalable. A lifestyle business supports the owner’s lifestyle, while a scalable business can grow without its owner. Each has a different structure and, thus, a different path for finding financing.
In this article, I’ll discuss the different ways to finance your business, as well as the pros and cons of each option. I’ll also provide some tips for finding the best financing for your needs.
Funding A Lifestyle Business
Lifestyle businesses can be further categorized into two subcategories: service-based and product-based. Both require a skillset that sets them apart and resources to expand. These resources typically involve financing in the early stages as the company plans to invest in people, equipment or supplies. One option is to use personal savings or family and friends to fund the business. If this is not possible, there are small-business loans available from banks or credit unions. The type of lifestyle business will affect the best type of loan.
Service-based businesses, such as attorneys, dentists and plumbers, need to finance their teams. One option for this is to consider a home equity line of credit (HELOC). HELOCs typically have lower interest rates than SBA loans and most service-based businesses operate on an hourly rate, so having a flexible loan that can be drawn down and paid off as needed provides more flexibility.
Product-based businesses, on the other hand, tend to require efficiency. I’ve found that factoring in finance, which uses accounts receivable as collateral for loans, can be a great way to finance things like factory expansion. However, it may not be ideal during a slow cycle as it can limit cash flow. In this case, businesses can usually find better financing from equipment and supplier manufacturers. Manufacturers and suppliers offer financing to help businesses purchase their products, which often comes with better interest rates than conventional or small business loans.
Funding A Scalable Business
Scalable businesses usually require significant investments to be profitable. This makes it difficult for them to be funded through conventional methods such as small business loans or bank loans. Instead, they may need to seek venture capital or angel investors.
Angel investors are high-net-worth individuals who are willing to take on the risk for a potential reward. They expect to receive up to ten times their investment within a decade. Venture capital firms can invest larger amounts and collectively will take around 20% of the company’s equity and expect returns around six to eight times their investment. They will often take a board seat and assist in growing the company’s product, team and sales strategy.
Find Savings In Operations
In addition to traditional financing options, businesses can also find savings in their operations. This can be a unique way to finance a business, as it can help to reduce costs and free up cash flow.
For service-based businesses, employees are typically the largest expense. One way to reduce this cost is to include employees as partners. This can give employees a vested interest in the company and encourage them to be more productive. Additionally, professional employment organizations (PEOs) or temp services can be used to outsource payroll and HR functions, which can save money on administrative costs.
Service-based businesses can also take advantage of tax breaks and incentives. One such incentive is the R&D tax credit, which is available to businesses that invest in research and development. This credit can offset payroll taxes for businesses with revenue under $5 million and can reduce income taxes for businesses with revenue over $5 million.
In addition to these general tips, businesses should also carefully monitor their spending.
This includes paying attention to what they pay for on credit cards. Many companies use solutions that manage their accounts payable, but these solutions can often charge processing fees. For large expenses, it may be more cost-effective to pay with cash or check. Businesses should also negotiate discounts with suppliers and vendors. Many suppliers offer discounts for prompt payment, and some may also offer discounts for paying with cash.
As well as the earlier mentioned R&D tax credit, scalable businesses can often qualify for small-business status exemption (QSBS). To qualify for QSBS, a business must be a C-corporation, valued at less than $50 million and owned for at least five years. The benefits of QSBS include a $10 million exception on capital gains taxes or ten times the original investment, whichever is more.
Starting a company isn’t easy, but I’ve found it to be very rewarding. Depending on the type of business you are starting, you will want to consider the right financing strategy and tools to meet your needs. By following these tips, I believe you can best position yourself to find the best financing option that will fund your operations and free up cash flow.
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