Raising Capital for a Small Business

Adequate funding is central to the success of any small to medium business, particularly during the costly start-up stage. When you require additional funds to set up a new small business venture or to expand an existing small business, two main ways of raising capital are normally considered: debt finance or equity finance (including venture capital investment). The choice that you make will depend largely upon the nature of your small business venture and how you intend to develop it.

The most common form of debt finance is a loan from a bank or other financial institution. Loans secured against assets are usually offered at more favorable rates of interest (and for larger amounts) than unsecured loans.

The majority of small business start-ups, by their very nature, simply do not have a credit or trading history that they can use to substantiate their applications for loans.

But, all is not lost when it comes to obtaining loans for new small businesses. Loans can be secured using existing business assets, such as business premises, equipment, machinery, company vehicles, pro-forma invoices and/or purchase orders. Small business loans secured in this manner are generally cheaper and easier to obtain than conventional, unsecured business loans. Since many small businesses have few assets, loans are commonly secured against the home of the business owner.

The term of the loan is normally agreed upon in advance. The rate of interest may be fixed or variable depending on the terms stipulated by the lender. If the small business defaults on the loan payments, the lending institution is entitled to take possession of the asset in order to reclaim any money owed on the loan.

If you are raising capital by way of equity finance then you are exchanging a stake in your business for a financial contribution. Many businesses raise capital by this method, asking friends and family to invest, so that they can avoid being dependent on the whim of some large, faceless, financial institution or a venture capital investor.

If the business prospers, then the investors will gain a return on their investment through payment of dividends and/or by taking the company public, enabling the sale of shares in the business.

To raise a large amount of equity finance capital, you may need to approach a venture capitalist. Not all businesses are likely to attract venture capital investment.

Venture capital investors prefer to invest in well-managed companies with good potential for rapid sustained expansion. Most venture capitalists would like to be able to sell their stake within a few years and obtain a good return on their investment.

Several different grants are available for small business start-ups, with grants offered by local state programs or other groups.

Unlike other forms of funding, including bank loans and investment loans, grants are not repayable, nor does the small business borrower pay interest on the amount of the grant. The downside, however, is the protracted and time-consuming procedure involved in applying for grants. In addition, grants are hard to come by, with fierce competition among small business start-ups who perceive grants as easy money when their small business needs it most.

Most U.S. government departments, such as the U.S. Small Business Administration, do not provide small business grants to start or expand a small business. Most grants are offered through state programs with very specific criteria.

Many small businesses lack sufficient security to obtain loans through mainstream financial institutions or to attract the necessary investment to finance their business. All too often, the major banks turn down applications for loans because the prospective small business owner cannot offer sufficient security to support the loans' applications. Despite presenting a convincing business plan, the risk to the bank of issuing unsecured loans is often considered too great.

So, what are the alternatives for small business start-ups that fail to secure loans or investment via conventional channels? One option is the Catalog of Federal Domestic Assistance, which provides a database of all forms of financial assistance (federal, state, and local government) to get your small business started. A wide variety of financial aid is available, each with different qualification criteria and application requirements.