Small business financing is a smaller subject than it appears. There are three instruments, they behave differently, and most bad outcomes come from applying one where another belonged.
Debt
You receive money and repay it with interest over a defined term. Ownership is unaffected; the obligation is fixed regardless of how the business performs.
Debt suits anything that produces a return you can point at: equipment that adds capacity, inventory that turns, a fit-out that opens a location, a vehicle for a trade that needs one. The question a lender asks is not whether the business is a good idea but whether the cash flow services the payment, and that is the question the borrower should ask first.
Sources run from community development lenders for smaller amounts through banks with a federal guarantee for larger ones. The micro loans page covers the small end, where most Baltimore businesses actually borrow.
What a lender is assessing
Five things, in roughly this order of weight for a young business: the owner’s personal credit history, the cash flow of the business against the proposed payment, the owner’s own contribution, whatever security exists, and whether the stated purpose makes sense.
The first of those surprises people. For a business without years of accounts, the owner’s credit record is the longest and most reliable dataset available, and it is read accordingly.
Equity
You sell a share of the business. Nothing is repaid; the investor’s return comes from the value of the share.
Equity feels like the cheapest capital available and is the most expensive if the business succeeds, because the share keeps earning forever. It is the right instrument only where the business needs more money than it can service as debt, and where the growth it buys is genuinely large. For most businesses neither condition holds.
Grants
Money that is not repaid, and the narrowest of the three. The realistic picture is that grants attach to projects, not to businesses: a specific piece of equipment, a facade improvement in a particular commercial district, an energy efficiency measure, a hiring program, or a category of owner the program was designed to reach.
Two consequences follow. Applications are written around the funder’s objective, and the money usually arrives after the spending, which means the business has to be able to fund it either way. The project-based funding page goes into this.
Anything advertising general small business start up grants in exchange for a fee is selling a list of publicly available programs. The genuine ones are free to find and difficult to win.
Matching the instrument to the need
| The need | Usually the right instrument |
|---|---|
| Equipment with a clear payback | Debt, term matched to the asset life |
| Inventory for a season | Short-term debt or a line of credit |
| Fit-out of premises | Debt, sometimes with a grant toward a specific element |
| The gap between invoicing and being paid | Invoice finance, or chasing the receivable |
| Losses while the model is proved | Owner capital, or nothing, this is what equity funds if anything does |
| A specific project a funder cares about | Grant, with the business able to fund it either way |
| Growth far beyond what cash flow supports | Equity |
The row that causes most damage is the fifth. Borrowing to cover losses converts a problem that could have been fixed by changing price or cost into a debt that has to be serviced while the same problem continues. Lenders can see it in the numbers, which is why applications of that shape are declined, and the decline is more useful than the money would have been.
The personal guarantee
Almost every small business loan carries one. It means the shield the entity provides does not extend to the bank, and it survives the failure of the business.
This is not a reason to avoid borrowing. It is a reason to borrow amounts the business can actually service, to read what is being guaranteed, and to understand that the choice of entity does not change this particular exposure at all.
Two details worth reading for. Whether the guarantee is unlimited or capped at a stated amount, and whether it is joint and several where there is more than one owner, which means any one guarantor can be pursued for the whole, not for their share. Both are negotiable more often than borrowers assume, particularly on a second facility with a lender who knows you.
The order to approach money in
For most small businesses the sequence that produces the best terms is consistent.
Your own capital first, to the extent it is available without risking the household. Lenders want to see it and it costs nothing.
Revenue, which is the cheapest capital in existence and the most overlooked. A deposit taken at order, a shorter payment term, or a prepaid package converts customers into the funding source and costs no interest.
A community development lender, for amounts under a few hundred thousand, with technical assistance attached.
A bank with a guarantee behind it, for larger amounts, longer terms and property.
Equity, last, and only where the first four cannot do it and the business is the kind equity suits.
Working down that list from the top usually produces cheaper money, and always produces a better-prepared application.
Reading an offer
Four numbers, always together: the rate, any origination or arrangement fee, the term, and whether early repayment is penalized.
A slightly higher rate over a longer term with no prepayment penalty is frequently cheaper in practice than a lower rate over a short one, because it leaves the business with cash to trade and the option to clear it early.
And one warning sign. Anything priced as a factor rate—“repay 1.3 times the advance”—rather than as an annual rate is not quoting you an interest rate, and the annualized cost over the real repayment period is usually several times what it appears. Work it out before signing.
When the answer is not financing
Three situations where borrowing makes things worse.
A margin problem. If the business loses money on each sale, a loan funds more losses.
An unproven model. Debt taken to extend the runway of something that has not found demand converts a survivable experiment into a personal liability.
A timing problem that is actually a collections problem. A business waiting ninety days for money it invoiced should chase the invoice before borrowing against it.