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Maybe you've seen ads proclaiming "Government grants for small businesses!" and it's got you wondering if a grant is a better option for business financing than a loan. Business grants and loans can both provide capital for business owners, but they have some major differences to consider. Unlike a loan, for instance, a grant does not have to be repaid. While the idea of free money is certainly appealing, grants—if you can find them—can come with lots of strings attached. Here's what you need to know about the difference between grants and business loans.
What Is a Business Grant?
Business grants come in all shapes and sizes, but they all have a couple of things in common. First, you don't have to repay the money from a grant. Second, the purpose of a grant is to help the granting organization achieve a goal. Federal grants, for instance, could be issued to provide public services, stimulate the economy, support critical recovery initiatives or facilitate innovative research. Meanwhile, Visa offers grants of up to $50,000 for products that deliver innovative payment and commerce solutions to consumers and businesses.
Grants can come from federal, state and local governments; nonprofit and community organizations; and for-profit companies. Many grants are designed to help business owners who have historically had trouble getting financing from banks and investors, such as women, military veterans and members of minority groups.
Competition for grants is fierce. You may see ads touting free grants to start a business, but most grants are for existing businesses, not startups. Having business experience gives the granting organization confidence you can use the grant responsibly to carry out the grant's intended goal.
To get a business grant, you'll first have to find a grant you are qualified for and complete the application process. Grant qualification requirements can be very strict, but some have more general criteria. The complexity of grant applications can also vary greatly: Some require lots of documentation; others are simple, like the one-page application for WomensNet grants, which award $2,000 to $25,000 to women entrepreneurs.
If your grant application is approved, the organization will dispense the grant money according to its rules. Grantors may also require you to submit ongoing financial records, give progress reports or demonstrate compliance with government regulations as you use the grant money.
You can search for grants with the Grants.gov search tool (although most of these grants are for entities that help business owners, not for business owners themselves). You can also find grants by contacting your state and local economic development agency, Small Business Administration district office, SCORE chapter or Small Business Development Center.
What Is a Business Loan?
Business loans are money you borrow that must be paid back. There are short-term business loans (generally six to 24 months) or long-term loans (usually three years or longer). While grants are intended to achieve a mission, bank loans are intended to make money for the lender. Therefore, a lender's primary concern is whether you'll be able to repay the loan, usually with interest. Many loans are reserved for companies that have been in business for at least a year or two and have a solid business foundation. Because new businesses are riskier investments for lenders, loans to start a business are harder to find.
You can get business loans from banks, credit unions, nonprofit organizations and online lenders. Online lenders focus on smaller, short-term loans and usually have less stringent lending criteria than traditional lenders. For example, they often lend to newer businesses or those with lower credit scores. You typically complete an application online; if approved, loans may fund in a matter of hours. However, online lenders generally charge higher interest rates than traditional lenders.
For business loans of $350,000 or more, or for long-term loans, a traditional lender such as a bank or credit union is usually your best bet. These lenders generally require a business plan, financial statements, income tax records and other documentation. They want you to prove that your business is profitable and explain how you'll use the loan to make it even more profitable.
Depending on how long you've been in business, lenders may consider your business credit, personal credit or both when assessing your business loan application. Check your business credit report, personal credit report and personal credit score before you begin looking for loans. Make sure your credit reports are accurate and take steps to improve your credit score if necessary. Compare offerings from several different lenders, including the annual percentage rate (APR), loan amounts available, loan terms and fees, to find the best options before you apply.
Comparing Grants and Business Loans
Every granting organization and lender has its own unique criteria. However, these are the key differences between grants and loans.
| Grants vs. Business Loans | ||
|---|---|---|
| Grants | Loans | |
| Justification | Money is used to benefit society or promote the grantor's mission | Money is used to help an individual business |
| Repayment | No repayment required | Repayment required |
| Availability | Given on competitive basis | Given based on financial soundness |
How to Decide Which Is Best for You
Should you apply for a loan or a grant? You might be a good candidate for a grant if:
- Your business benefits your community or society. For example, do you provide arts education in low-income communities or hire formerly incarcerated people?
- You aren't in urgent need of money. Finding and applying for grants can take a long time. Many grants are awarded annually; if you miss the application deadline, you'll have to wait until next year.
- You're willing to accept the grantor's restrictions. Be prepared to follow the granting organization's rules, such as regularly reporting on your progress or participating in publicity campaigns.
A loan is probably a better solution if:
- Your business is profitable and has good financials. If you can demonstrate ability to repay the loan, you'll find many more options for loans than grants.
- You need money fast. You can apply for a loan whenever you want and often get money right away, depending on the lender.
- You want to control how you use the money. There are loans for different purposes—for example, working capital or real estate—but overall, you have more freedom in using the money than with a grant.
Alternative Sources of Business Funding
In addition to loans and grants, consider these ways to finance your business.
- Credit cards: A business credit card can provide the purchasing power to accomplish your goals. For example, suppose your toy store needs inventory to prepare for a rush of holiday sales. You can use a credit card to buy the inventory, sell the goods and use the profits to pay the credit card bill. Business credit card issuers evaluate your personal credit, so make sure your credit score is in good shape before you apply.
- Family and friends: Why not see if the people who believe in you most can help your business grow? Family and friends may be able to lend you money or invest money in return for part ownership in your business. Always treat these transactions professionally; draw up paperwork that goes over the loan or investment details, and pay back any money you borrow.
- Angel investors: Angels are wealthy individuals who invest in promising companies, either individually or as part of a group. Often, angels offer business expertise as well as cash. You can find angels through referrals from other business owners or professionals.
- Equipment financing: Like an auto loan uses the vehicle you buy as collateral, an equipment loan uses business equipment to secure the loan. Online lenders and equipment financing companies offer equipment loans; many equipment manufacturers or resellers do too.
- Peer-to-peer lending: Peer-to-peer lending websites connect individuals seeking money with other individuals willing to lend it. This can be a good option if you don't need a lot of money.
- Crowdfunding: Sites such as GoFundMe and Kickstarter allow companies to solicit donations from individuals—usually to fund a product launch. You'll need to offer something in return for crowdfunding contributions and work hard to promote your campaign.
Finding the Right Financing for Your Business
If you can find a business grant for which you're qualified, there's no downside to applying—it's free money, after all. But since grants are very competitive, don't pin all your hopes on winning the award. Choose one of the solutions above to quickly get the capital you need; then apply for the grant as backup. When it comes to financing business growth, smart entrepreneurs always keep their options open.