Great business ideas often start on the back of a napkin or during a late-night brainstorming session – actually – a lot of my greatest business ideas have happened in the shower! But sometimes (not every time) turning those ideas into a functioning reality requires fuel. In the business world, that fuel is capital.
Finding the money to start or grow a business can feel overwhelming. You might hear terms like “equity,” “collateral,” or “bootstrapping” tossed around and wonder what language everyone is speaking. Don’t worry. Financing isn’t as complicated as it sounds once you break it down.
In this blog we’re going to explore the most common ways to finance a small business. We will translate the complex financial jargon into plain English and help you weigh your options so you can make the best decision for your company’s future.
Starting with what you have: Bootstrapping
Before you walk into a bank, or pitch to an investor, look at your own pockets. This is often the first step for many entrepreneurs. In the business world, this is called bootstrapping.
What is Bootstrapping?
Bootstrapping means starting a company with little capital, relying on your personal finances and the revenue the new business generates. You aren’t asking anyone else for money. instead, you are funding the operation yourself.
This might involve using your savings account, cashing out personal investments, or simply keeping your day job while you build your business on the side.
The Pros and Cons
The biggest advantage of bootstrapping is control. Because you aren’t taking money from outside sources, you don’t answer to anyone. You retain 100% ownership of your business. You also avoid debt, which means you don’t have monthly loan payments hanging over your head.
However, the risk is entirely yours. If the business fails, your personal savings are gone. Bootstrapping can also limit how fast you can grow. Without a large injection of cash, you can only expand as fast as your profits allow.
Borrowing money: Debt Financing
If your savings aren’t enough, you might consider borrowing money. This is known as debt financing. It’s exactly what it sounds like: you borrow money now and pay it back later, usually with interest.
Traditional Bank Loans
Going to a bank is the classic route. Banks offer term loans, where you receive a lump sum of cash and pay it back over a set period.
When you apply, the bank will look at your credit score and your business plan. They will likely ask for collateral.
JARGON ALERT: Collateral.
This refers to an asset (something of value) that you pledge to the lender to secure the loan. If you can’t pay back the loan, the bank can take the collateral. This could be your house, your car, or business equipment.
Funding Circle
In the UK, the government supports new businesses through their Funding Circle programme. Funding Circle was founded in 2010 – it works with the UK government-owned British Business Bank to provide government-backed loans, including the Growth Guarantee Scheme. While Funding Circle itself is not a government entity, it is an accredited partner that offers loans with a 70% government guarantee to lenders for eligible small businesses.
SBA Loans
In the United States, the Small Business Administration (SBA) helps small businesses get loans. The SBA doesn’t lend you the money directly. Instead, they guarantee a portion of the loan for the bank. This reduces the risk for the bank, making them more willing to lend to you.
Lines of Credit
Another form of debt financing is a business line of credit. Think of this like a credit card for your business. You get approved for a certain amount, say 50k. You don’t have to use it all at once. You can draw from it as needed and only pay interest on the amount you actually use. This is excellent for managing cash flow.
JARGON ALERT: Cash Flow
This is the movement of money in and out of your business. Positive cash flow means more money is coming in than going out. A line of credit helps when cash flow is tight—for example, when you need to buy inventory but haven’t sold it yet.
Selling a Piece of the Pie: Equity Financing
If you don’t want to take on debt, or if banks won’t lend to you, you might look for investors. This is called equity financing. Instead of borrowing money, you sell a portion of your ownership stake in the company in exchange for cash.
Angel Investors
Angel investors are typically wealthy individuals who invest their own money into startups. They often invest in the early stages when the risk is high. In exchange, they get equity (ownership) in your company.
Beyond just money, angel investors often provide mentorship and valuable industry connections. They want you to succeed because your success is their profit.
Venture Capital (VC)
Venture capital firms are professional investment groups. They manage pooled money from many investors and put it into high-growth companies. VCs usually come in later than angel investors, when the business has a proven track record but needs massive capital to scale up quickly.
The Trade-Off
The main benefit of equity financing is that you don’t have to pay the money back. If the business fails, the investors lose their money, not you.
The downside is that you lose some control. Investors become part-owners. They will have a say in how you run the business. If you give away too much equity, you might eventually find yourself being outvoted in your own company.
Free Money (Sort of): Grants
Grants are the holy grail of business financing. A grant is a sum of money given to a business that does not need to be repaid. It is not a loan, and you don’t have to give up equity.
However, grants are highly competitive. They are often specific to certain industries (like technology or agriculture) or demographics (like women-owned or veteran-owned businesses).
The application process can be long and tedious. You must prove exactly how you will use the funds and often report back on your progress. While it sounds like “free money,” the cost here is the time and effort required to secure it.
How to Evaluate Your Options
With so many choices, how do you decide? Here are three practical tips to help you evaluate your financing options.
1. Calculate the Cost of Capital
Every dollar you get has a cost. For a loan, the cost is the interest rate. For equity, the cost is the share of future profits you are giving away.
JARGON ALERT: Cost of Capital This is simply the price you pay for the money you use to fund your business. Compare these costs. Is it cheaper to pay 8% interest to a bank, or to give away 20% of your company to an investor? The answer depends on how profitable you expect to be.
2. Assess Your Risk Tolerance
Ask yourself how comfortable you are with debt. If the idea of monthly loan payments keeps you up at night, debt financing might not be for you. If you are terrified of losing control of your vision, equity financing might be a bad fit.
3. Consider Your Stage of Growth
Just starting out? Bootstrapping or friends and family are often best. Need equipment or inventory? A bank loan or line of credit works well because you have assets to use as collateral. Ready to explode into a national brand? Venture capital might be necessary to fuel that rapid expansion.
Conclusion
Financing a small business is a journey, not a single transaction. You might start by bootstrapping, move on to a small bank loan, and eventually bring on an investor. The key is to understand what you are signing up for.
Don’t let the jargon scare you. Whether you are dealing with equity, collateral, or cash flow, these are just tools to help you build. Take the time to review your business plan, understand your financial needs, and choose the option that aligns with your long-term goals.
Ready to take the next step? Start by organizing your financial records today. Clean, accurate books are the first thing any lender or investor will want to see. Visit our resources page for a checklist on preparing your business for funding.
Time to Learn More?
We cover this topic in more detail within the Hub through our easy to follow, bite-sized videos, quicksheets, and templates. If you’d like to learn more about this, or any element of business finance, you’ll find everything you need to know in The Hub.
You’ll also find our amazing community of Hubsters to help, advise and support you in your journey.