Where do you get financing for your small business?

“It takes money to make money.” That saying is somewhat true. To create or expand your business empire, you will need some funds to cover your expenses until your income comes in. That may take 2 months or 2 years, and may require $200 or $200,000. Money can always be found, one way or another, but you need the method that’s right for you.

Money comes from three sources, each with its own benefits, dangers, and costs. You will likely use two, if not all three of these types over the course of your business, and you need to understand each one to assess which one will work for you today, tomorrow, and 5 years from now.

Method #1: Self-financing

When business owners have cash on hand, they often look to their own bank account first as a simple form of financing. Self-financing can be divided into two different forms, each with their own considerations. First, there are two types of self-financing: lump sum and self-financing. Second, self-funding can come from you, personally, or it can come from your current business funding another business, company, service, or product line.

Lump sum financing is when you have a set amount of money from the sale of a business or investment, an inheritance, personal savings, 401(k) cash withdrawal (rarely a good idea), or other amount of cash that can use to finance a business venture. The amount you have available is relatively fixed and can be viewed and tracked as a single investment.

Bootstrapping is used constantly by most small businesses, usually without conscious knowledge. Bootstrapping is where you pay for the new or expanding business through cash flow from another source. The other source could be your day job, your spouse’s or partner’s job or business, a profitable business or product line, or passive investments (real estate, mutual funds, and bonds).

Self-financing works when you need a small amount of money, have a large amount of money available, are comfortable with risk, or need money fast. It also works when a profitable business can absorb investment in a new venture until the new venture gets off the ground; assuming proper cash flow projections and tracking have been done to ensure the new venture isn’t a never-ending waste of profit.

Method #2: Debt Financing

Debt financing is obtaining money that must be paid back to the lender, usually with interest. Like self-financing, debt financing can include using both your personal credit and business credit and security to obtain a loan or line of credit.

Personal debt financing is readily available to most business owners. If you have decent credit, you can get credit cards, a home equity line of credit, or a loan, without telling the bank about your business. You can get a loan from a family member or friend who knows your business but doesn’t hold such exacting standards as a formal bank.

Businesses can also obtain credit cards, lines of credit, and loans from banks and credit unions. Small Business Administration (SBA) guaranteed loans are available through banks that provide lines of credit to small businesses that may not be able to obtain credit without SBA guarantee. Alternative debt financing options, such as Prosper.com, allow individuals and businesses with lower credit scores to obtain financing from a variety of sources. But these private loans will generally have higher interest rates than SBA loans.

Method #3: Equity financing

Equity financing is giving up ownership (equity) of your business and potential future earnings for money (equity) today.

Investors can come in the form of silent associates, family members, friends, or private investors speculating on startups. Angel Funding, wealthy individuals and groups who invest in small, high-growth businesses, typically buy stakes in companies for a few hundred thousand dollars. Venture capital firms and investment banks often look for companies in which they will invest millions of dollars.

If you plan to seek private investors, angel funds, investment banks, or venture capital, you may need more sophisticated financial reports than those covered in this book. You will also need more lawyers and accountants.

How do you decide what type of financing to look for?

Most likely, one type of financing is obviously not right for you right now. You will probably use two or even all three types of financing for any business, and your choice may change throughout the life of the business as it expands and adds new ventures. You may be able to rule out certain options because they’re not available: you don’t have cash or another source of income (self), you don’t have a good personal credit rating (debt), or your business has no outlet. flat (equity).

For each decision, you need to track the benefits (return on investment) and costs (interest, fees, and lost profit) of each type of financing. As your business grows, you may need to add or change financing as previous financing methods become too expensive, dry up, or do not produce a sufficient return.