- Debt financing is an accessible method of funding for many small businesses, but there are also risks to consider before applying for credit or loans.
- That's why Harvard alumna and funding expert Arielle Loren advises entrepreneurs to keep their jobs as backup income when they're first starting their businesses.
- Most importantly, Loren says, don't take out more than you're comfortable repaying.
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There's a reason Arielle Loren named her business-funding app 100K Incubator - and it's a reason that's all too familiar to American business owners.
According to Fundera, 86.3% of small business owners make less than $100,000 a year in income. For many entrepreneurs, getting capital is the biggest obstacle to hitting that $100K mark.
Loren, a Harvard alumna and business strategist, is trying to make that number more reachable - specifically for women and women of color, who combined only get 2.2% of venture capital in the US. This is a stat she knows well, as she's experienced the struggle to get capital firsthand.
"I remember what it was like being an early stage entrepreneur, not making six figures, and struggling to figure out what my funding options were," Loren told Business Insider. And she found most women entrepreneurs in the early stages of their businesses experienced the same issues.
"It was either you were going after an investor, or you were stuck with a cash-only business where you were limited to reinvesting your business' profits to scale," she said.
Loren spent a decade in consulting and fundraising, and she ran a marketing and business-development agency for five years. Then, she decided to use her knowledge and experience to help other women. She started the business-funding education app for women, 100K Incubator, with the goal of getting 100,000 women entrepreneurs to reach $100,000 in annual sales. Since launching in 2018, the app has helped 1,000 women access over $1 million in total capital.
However, venture capital isn't the only option for funding. Part of Loren's app includes a 50-course online bootcamp, while one module explains the 12 different types of funding available to small business owners. The first options she teaches to entrepreneurs in their earliest stages are business credit cards, personal loans, and home equity loans and lines of credit.
These three options fall under debt financing, which is more accessible than equity financing, but do present risks. Some loans can take up to 30 years to pay off, and any missed payments could put a gash in your credit score and ruin your chances of securing funding later on.
That's why Loren advises entrepreneurs to keep their jobs when they're first starting out, not only to pay their personal expenses, but to have backup income. "The most important thing is to never take out funding that you're not comfortable repaying on the repayment term," Loren told Business Insider.
There are some important factors to consider before you apply for a loan or credit, to make sure you're not borrowing more money than you can pay back.
Interest rate
Plans are going to vary from bank to bank, but interest rates can also depend on your credit history. The lower your credit score, the higher your interest rate is likely to be. Factor this into the total amount you're borrowing - a few thousand dollars can easily accumulate, even if you're making your minimum repayments on time.
Repayment term
You'll also need to think about the length of time you agree upon for repayment. Some loans only take a few months or a couple years to pay back. Others could take 20 to 30 years, so be sure you're able to make that commitment.
If you want to repay your loan in less time than your agreed term, you could be charged fees for early repayment. Consider whether that's an additional fee you're willing to pay - otherwise, you may be locked into debt repayment for the full term of your loan.
Borrowing from friends and family
Loren said that these factors apply just the same if you're borrowing money or getting investments from friends and family. "Business is still business regardless of whether it's family or not," she said.
If you're confident you can effectively mix personal relationships into your business, Loren suggests treating them just like business partnerships. Pay back your debt on time and keep them updated on how your business is doing.
"If you do default on a payment or you do lose them money, is the impact going to be so severe that you lose out on that relationship?" Loren said.
From starting your business to expanding after several years, debt financing is easier to access than equity or venture funding. If you repay your debt on time, it can also help you improve your credit history to apply for more capital in the future.