Where do most small business owners get the money to start their businesses? Overall, nearly three-fourths (73 percent) of small businesses used some type of financing in the past 12 months, reports the Small Business Administration (SBA).
Here's a closer look at where entrepreneurs are getting the capital they need.
Personal equity and traditional debt are the primary sources of financing for startup entrepreneurs. Nearly six in 10 startup business owners (57 percent) use their personal savings for startup capital. In addition, one-fourth of startups launch their businesses without any startup capital. This approach is most common for startups that don't have any employees.
Here's how the rest of the startups’ financing sources break down:
- Personal credit card: 8 percent
- Bank loan: 8 percent
- Other personal assets: 6 percent
- Home equity: 3 percent
- Business credit card: 2 percent
If you take personal credit cards, “other personal assets” and home equity into consideration, the percentage of startup owners using their own money to launch their businesses reaches 74 percent.
Starting with your own money is a little easier to do if, like most startups, you launch on a shoestring. Beyond the entrepreneurs who use no startup capital at all, some 62 percent of companies that do use startup capital launch with less than $5,000, according to the SBA. About 21 percent start up with between $10,000 and $24,999 in capital. Slightly more than 14 percent have between $50,000 and $99,999 to start their businesses. Less than 10 percent have startup capital of $250,000 or more; these are more likely to be employer firms.
While the majority of all types of businesses start with no outside financing, women-owned businesses are even more likely to do so than startups owned by men. More than twice as many men as women (8.5 percent vs. 3.6 percent) use bank loans to finance their startups.
Businesses owned by African Americans and Hispanics are also much less likely to use bank loans than businesses owned by Asians or Caucasians. Instead, these entrepreneurs tend to turn to personal credit cards for startup capital.
While the idea of starting a business without taking on a bank loan may seem like a smart move, especially if you’re brought up to fear getting in debt, the SBA notes it can put women and minority entrepreneurs at a disadvantage. By not approaching banks for loans, these entrepreneurs are failing to establish a strong banking relationship during their businesses' critical early years. Having a relationship with a banker is invaluable later on if you need financing for working capital or expansion.
About two-thirds of small business owners do have some debt, the SBA says. Using debt to launch or expand your business isn't a bad move, as long as you do so wisely.
Some debt do's and don'ts to keep in mind:
- Do write a business plan. Especially for a startup, a business plan will help you think through your strategy and determine how much money you need to borrow, as well as convince prospective lenders that will be successful enough to repay the loan.
- Don't bite off more than you can chew. Startup business owners tend to be overly optimistic about their prospects for success. Taking a more conservative view of your financial forecasts will not only impress lenders, but also ensure that you don't get in over your head by borrowing more than you can realistically pay back.
- Do put down some money of your own. Lenders want to see that you have enough confidence in your startup to invest your own money in it. You really can’t expect to get a loan if you aren't willing to take some risk yourself.
- Don't rely entirely on personal debt. When you use personal credit cards or home equity to finance your startup, you're putting your own credit rating (and potentially your home) in jeopardy. But even if you successfully pay off the personal debt, you aren't building a good credit rating for your business by doing so. Try to obtain business credit cards and business financing instead — it will get your company off on the right foot and help it build a good reputation.