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An acronym for generally accepted accounting principles, GAAP is a set of rules and principles that public companies in the U.S. must follow when preparing their annual financial statements.

Without GAAP, it would be much more difficult for lenders, investors, and other interested parties to know whether a business is performing well or poorly.

Read on to learn more on what GAAP is and how it works, pros and cons of GAAP, the differences between GAAP and non-GAAP, and more.

GAAP Defined

GAAP, or generally accepted accounting principles, is a commonly recognized set of rules and procedures designed to govern corporate accounting and financial reporting in the U.S.

GAAP was established to provide consistency in how financial statements are created, eliminate the potential for fraudulent or misleading financial reports, and make it easier for investors and creditors to evaluate companies and compare them apples-to-apples.

All publicly traded businesses in the U.S. must use GAAP in their financial statements. While small businesses that don’t get audited aren’t required to use GAAP, doing so can still be helpful, particularly if your business may be interested in attracting an investor or exploring small business loans at some point.

How GAAP Works

Three nonprofit organizations — the Financial Accounting Foundation (FAF), Financial Accounting Standards Board (FASB), and Governmental Accounting Standards Board (GASB) — play a role in setting GAAP standards as follows:

•  FAF oversees the FASB and GASB organizations

•  FASB issues GAAP rules for businesses and nonprofits

•  GASB issues GAAP standards for state and local governments

For businesses filing periodic reports with the U.S. Securities and Exchange Commission (SEC), GAAP dictates how a company can recognize revenue and expenses and how information needs to be presented to shareholders in an audited report. It also standardizes the financial reporting process so that third parties can easily compare and contrast two GAAP-compliant companies or entities.

GAAP incorporates three components to help eliminate misleading accounting and financial reporting practices:

•  10 accounting principles

•  Rules and standards issued by the FASB or GASB

•  Generally accepted industry practices

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Pros and Cons of GAAP

GAAP offers a number of benefits. It guides companies in preparing accurate and clear financial data, reduces fraudulent financial reporting, and provides consistency in the financial statements of one GAAP-compliant company to another.

However, GAAP also has some limitations. Its “one-size-fits-all” approach to financial reporting, for example, doesn’t always address issues faced by specific industries. GAAP can also be overly complex, as well as costly to implement, for smaller businesses. And, it’s not a globally used standard, which can make it challenging for international organizations and for investors who want to compare companies operating in different countries.

Pros of GAAP

Here are some of the pros of GAAP:

•  Fosters honesty and transparency in financial reporting

•  Makes it easy to compare one GAAP-compliant company to another GAAP-compliant company

•  Ensures that businesses follow the same accounting principles for all reporting periods

•  Enables businesses to compare their performance with that of their competitors

Cons of GAAP

Here are some of the cons of GAAP:

•  Strict accounting model does not address many industry-specific situations

•  Can be costly for smaller companies to become GAAP-compliant

•  Overshadows non-U.S. GAAP financial performance metrics, such as adjusted EBITDA

•  Not a global standard

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10 Important GAAP Principles

GAAP has 10 fundamental principles companies must follow:

1. Principle of Regularity

Accountants must adhere to the rules and regulations of GAAP accounting. This principle keeps accountants from making up their own methods. With GAAP, any accountant can understand the work of another accountant. This is extremely important when comparing businesses and analyzing their worth.

2. Principle of Consistency

Accountants must apply the same standards and techniques for all accounting periods. This ensures financial comparability between periods. Any changes or updated standards must be explained in the footnotes to the financial statements.

3. Principle of Sincerity

Accountants must be as honest, impartial, and accurate in their reporting of a company’s financial performance as possible. They cannot lie or fudge numbers to make a company seem more profitable.

4. Principle of Permanence of Methods

All GAAP-compliant companies must be consistent with their methods and procedures. By doing so, all GAAP-compliant companies can be compared regardless of their industry.

5. Principle of Non-Compensation

Businesses must report all aspects of their performance, both good and bad, and without the expectation of debt compensation.

6. Principle of Prudence

Accountants should never speculate or give their opinion in a financial report. All records must only include expenses and provisions for spending that have or will certainly take place.

7. Principle of Continuity

While valuing assets, accountants must assume the business will continue to operate in the foreseeable future. Any potential buyouts or foreclosures should not be considered.

8. Principle of Periodicity

Accountants must report all revenue and expenses in the appropriate accounting period, such as fiscal quarters or fiscal years.

9. Principle of Materiality

Accountants must strive to fully disclose all financial data and accounting information in financial reports.

10. Principle of Utmost Good Faith

All parties that contribute to a company’s financial report are assumed to be honest and reputable.

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Alternatives to GAAP

IFRS

The International Financial Reporting Standards, or IFRS, are another set of accounting standards, but these are used at the international level. IFRS is standard in the European Union and many countries in Asia and South America, but not in the United States. IFRS was established so that companies could be comparable from country to country.

The main difference between GAAP vs. IFRS is that GAAP prioritizes rules and detailed guidelines, whereas IFRS only provides general principles to follow. Accountants have more leeway when following IFRS, but often need to include explanatory documents. On the other hand, businesses that use GAAP may feel confined by the lengthy rules.

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Tax Basis

Tax basis accounting follows the accounting that a company is required to use for filing its federal tax return. If allowed by creditors, investors, and other financial statement users, tax basis accounting can make sense for a privately held company, since it means less work when preparing the company’s tax return. When comparing tax-basis vs. GAAP accounting, tax basis accounting is less complex and often leads to less footnote disclosures in financial statements.

GAAS

Generally accepted auditing standards, or GAAS, is the framework that guides auditors. GAAS standards help auditors prepare a transparent and reliable audit report on companies. Following these standards also ensures that auditors don’t miss any important information. When comparing them, it’s important to remember that GAAP is used by accountants, whereas GAAS is used by auditors. Therefore, an auditor following GAAS may see how well a company is following GAAP.

The Takeaway

GAAP is the set of accounting rules and principles that public U.S. companies must follow when putting together financial statements. The goal of GAAP is to hold publicly traded companies accountable and ensure their financial statements are complete, consistent, and comparable.

For small business accounting, you are not required to follow GAAP regulations. However, doing so can make it easier for outsiders to evaluate your business and compare it with other companies in your industry. Publishing GAAP-compliant financial statements could make it easier for your business to attract an investor or get approved for certain types of business loans.

If you’re seeking financing for your business, SoFi can help. On SoFi’s marketplace, you can shop top providers today to access the capital you need. Find a personalized business financing option today in minutes.

FAQ

How many principles does GAAP have?

The generally accepted accounting principles, or GAAP, has ten principles. They are:

1.   Principle of regularity

2.   Principle of consistency

3.   Principle of sincerity

4.   Principle of permanence of methods

5.   Principle of non-compensation

6.   Principle of prudence

7.   Principle of continuity

8.   Principle of periodicity

9.   Principle of materiality

10.   Principle of utmost good faith

Is GAAP the same in every country?

No, only U.S. publicly traded companies must use GAAP (generally accepted accounting principles). IFRS (the International Financial Reporting Standards) is used in the European Union and many countries in Asia and South America.

Why is GAAP important?

GAAP (generally accepted accounting principles) is important because it ensures honesty, transparency, and uniformity in financial reporting. Without GAAP standards, businesses could report their earnings differently, which could make it difficult for investors and creditors to evaluate and compare companies, and could also provide opportunities for fraud.

What does GAAP stand for?

GAAP is the acronym for generally accepted accounting principles, a comprehensive framework of accounting rules. GAAP is primarily used in corporate accounting and financial reporting in the United States.

Who oversees GAAP?

Three nonprofit organizations — the Financial Accounting Foundation (FAF), Financial Accounting Standards Board (FASB), and Governmental Accounting Standards Board (GASB) — play a role in setting GAAP standards. FAF oversees the FASB and GASB organizations, while FASB issues GAAP rules for businesses and nonprofits and GASB issues GAAP standards for state and local governments. The U.S. Securities and Exchange Commission (SEC) can establish GAAP via government regulations, but it typically allows the private sector to establish the standards.

Photo credit: iStock/AndreyPopov

SoFi's marketplace is owned and operated by SoFi Lending Corp. See SoFi Lending Corp. licensing information below. Advertising Disclosures: SoFi receives compensation in the event you obtain a loan through SoFi’s marketplace. This affects whether a product or service is featured on this site and could affect the order of presentation. SoFi does not include all products and services in the market. All rates, terms, and conditions vary by provider.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.

Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.

SOSB0424058

Many legal fees for a business are tax-deductible for a business. The general rule of thumb is that if the legal fee is related to your business in any way, it can likely be deducted on your taxes. Therefore, it’s important to keep detailed records of your legal expenses throughout the year because you may be able to write them off during tax season.

Read on for a closer look at which legal fees are considered business tax deductions and which aren’t, plus tips on how to write off legal expenses when filing your taxes.

Can Legal Fees Be Deductible for a Business?

Generally, yes. The Internal Revenue Service (IRS) allows businesses to deduct legal and professional fees if they are “ordinary and necessary” expenses for the business. This typically includes fees for legal counsel, help forming your business, and fees incurred during a court case, even if you lost the case. As long as the legal fee relates to the daily operations of your business in some way, it is likely tax-deductible.

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Common Legal Fees That Are Deductible

You may be able to deduct the following business-related legal fees:

•   Attorney fees for filing and defending against lawsuits

•   Business bankruptcy legal expenses

•   Business incorporation expenses

•   Business planning expenses

•   Business tax fees

•   Commercial real estate closing expenses

•   Court costs and attorney fees revolving around the collection of taxable income

•   Drafting and reviewing contracts

•   Immigration expenses (for hiring and moving non U.S. residents to the U.S.)

•   Legal fees related to criminal charges against your business

•   Unlawful discrimination claims

•   Whistleblower claim

What Legal Fees Aren’t Deductible?

Generally, any legal fees that aren’t related to your business are not tax-deductible. This means that all of the following common legal fees cannot be deducted from your business income:

•   Divorce

•   Child custody

•   Personal injury

•   Estate planning/will preparation

•   Civil/criminal charges revolving around a political campaign

•   Civil/criminal charges revolving around any personal relationships outside of work

•   Legal fees related to the purchase of real estate for personal use

•   Nonbusiness tax advice

•   Fees related to collection, determination, or refund of taxes

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How Much Can Be Deducted?

After the first year of business, the IRS does not list a specific amount that a business can deduct. The key thing to remember is that the legal fee or lawsuit expense must be related to your business. While anything relating to money can affect a small business owner’s ability to run and manage their company, the fees likely cannot be deducted if the lawsuit is not related to the company itself.

There are, however, limitations on how much a startup can deduct — on legal and other expenses — during their first year of business (more on that below).

What Documentation Is Required to Deduct Legal Fees?

In general, you want to save all documentation related to lawsuits and legal fees in case you are audited.

Be sure that any invoices you receive from your attorneys clearly state the kind of the services that were provided. If the invoice you receive doesn’t specify the type of legal advice or counsel, you’ll want to ask the attorney to provide a more detailed invoice. That way, you’ll be able to substantiate any legal fees that you deduct on your taxes in the event of an audit.

Your business structure determines how you should go about deducting legal fees on your tax return. If you’re a sole proprietor or single-member LLC, there are tax benefits. You’ll list these expenses in the “Expenses” section of your Schedule C. If your business is a partnership or multiple-member LLC, you’ll list them in the “Deductions” section of Form 1065. Corporations put these expenses in the “Deductions” section of Form 1120.

If you have to amortize startup and organizational costs, you would include them in “Other Expenses” on your business tax return.

Can You Deduct Legal Fees From an On-Going Lawsuit?

Typically, yes, but the lawsuit must directly relate to your business. For example, if there’s a contract dispute between your company and another company, any legal fees relating to the case would likely be deductible. Whether or not a legal fee is deductible as a business expense does not depend on the outcome of a lawsuit.

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Can Small Businesses Deduct Startup Expenses?

Yes — up to a limit. If you started a business this year, any fees you paid to lawyers to help you incorporate or organize your business may be deductible. This includes fees for services performed by an attorney to help you file business registration documents with your state or prepare corporation bylaws, as well as partnership filing fees.

Typically, you can deduct up to $5,000 in business organizational expenses the year that you begin business. If your expenses were higher than that, then you will need to amortize any remaining amounts over 15 years.

Legal fees aren’t the only costs that can be deducted as a startup, however. You can also deduct up to $5,000 in startup expenses, which can include:

•   Market research expenses

•   Product research

•   Possibly interest on a small business loan

•   Cost of searching for and securing an office or workspace

•   Advertising

•   Wages and salaries for training

•   Professional and consultant fees

•   Costs associated with acquiring an existing business

•   Costs of leasing a business property

•   Equipment costs

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The Takeaway

Legal fees are often tax-deductible, but the fees or lawsuit must relate to your business. To deduct legal fees, you’ll need to keep any and all paperwork you receive that relates to the legal matter. Should you be audited, you want to have extensive documentation that proves your deductions are legitimate.

Also keep in mind that interest you pay on any small business financing is deductible as a business expense.

If you’re seeking financing for your business, SoFi can help. On SoFi’s marketplace, you can shop top providers today to access the capital you need. Find a personalized business financing option today in minutes.

FAQ

Can you deduct legal fees if a lawsuit is ongoing?

If the lawsuit is related to your business, then you may be able to deduct the legal fees, regardless of the outcome of the suit. If the lawsuit is a personal affair, you cannot deduct the fees even if they interrupt your business’s day-to-day operations. If the line is blurry, keep detailed records of all fees and court orders and consult a tax professional.

Can you deduct tax preparation fees?

If you are self-employed or own a business, you can generally deduct tax preparation fees as a business expense. Just keep in mind that you can only claim the portion of your accountant’s fee that is attributable to preparing the business-related part of your tax return, such as your Schedule C, E, or F.

Are LLC fees tax-deductible?

Yes, any formation fees you pay to become a limited liability company (LLC) are generally tax-deductible. Some other expenses you may be able to write off include accounting fees, fees for completing your articles of organization, and LLC filing fees.

Who qualifies for the 20% pass-through deduction?

To qualify for the 20% pass through deduction, you must have what is known as a “pass-through” business. This means any income your business makes “passes through” to your personal tax return, and includes sole proprietors, partnerships, limited liability companies (LLCs), and S Corporations.

What is the maximum deduction for a small business?

After the initial startup phase, there is no limit on how much a business can deduct. However, some expenses are capped at certain percentages. Startup costs can be deducted for the tax year in which your business is up and running and earning income. You can deduct up to $5,000 of business startup costs and up to $5,000 of organizational costs. Any remaining costs must be amortized over 15 years.

Photo credit: iStock/mediaphotos

SoFi's marketplace is owned and operated by SoFi Lending Corp. See SoFi Lending Corp. licensing information below. Advertising Disclosures: SoFi receives compensation in the event you obtain a loan through SoFi’s marketplace. This affects whether a product or service is featured on this site and could affect the order of presentation. SoFi does not include all products and services in the market. All rates, terms, and conditions vary by provider.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.

This article is not intended to be legal advice. Please consult an attorney for advice.

Non affiliation: SoFi isn’t affiliated with any of the companies highlighted in this article.

SOSB0424061

To stay relevant and competitive, your business has to grow. But planning for the future and putting business growth strategies into action can be challenging.

Following the uncertainty of the past couple of years (thanks to inflation and interest rate adjustments aimed at controlling it), many business owners are looking for ways to stay flexible while also seizing new opportunities for expansion. To stay ahead of the pack, consider these 11 strategies to set yourself up for business growth in 2024.

1. Reduce Risks

Whether you’re getting a new business off the ground or already have a few years under your belt, risk management is an important consideration. About 20% of small businesses fail in their first year, and almost half don’t survive beyond five years. Growing too fast is one risk that could possibly sink a new or expanding venture.

Diversifying your business’s revenue streams through new products or services and increasing your client base may be a couple of ways to become more resilient to risk.But minimizing your risk even when taking those steps is also a good idea. Before investing in a new product launch, for example, you may want to conducti a break-even analysis to identify how many units must be sold to cover production costs.

Researching the market for your products or services can be helpful in that it lets you identify demand and growth potential before you invest money. Addressing an unmet need or niche is generally less risky than entering a saturated market with more established competitors.

Buying insurance coverage is another option to proactively protect your business. Depending on the type of business and assets, this could include general liability insurance, commercial property insurance, or product liability insurance. While this does increase a business’s fixed monthly costs, it could avoid a costly scenario or litigation.

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2. Focus on Customer Experience

Customers and clients are critical to the success of any business. Enhancing their experience can help you gain repeat customers and recruit new consumers to spur business. Here are some strategies that can help.

Building a Sales Funnel

Whereas customer service is limited to direct interactions, customer experience encompasses everything a business offers, including the product or service you’re providing, shipping, packaging, advertising, and ease of use.

Learning how customers feel about certain aspects of your business is easier if you plan ahead.

Collecting customer information at checkout(such as a phone number and email address), for instance, can help your business maintain ongoing engagement with sales offers and capture feedback with a follow-up survey.

Customer Management Systems

Once communication is established, you can enhance customer experience by providing useful tips for using your products, as well as promotional offerings. Personalizing advertising campaigns and streamlining the purchase process can also enhance customer satisfaction.

You can integrate customer convenience and satisfaction into your relationship with customers beyond the transaction stage. Customer-oriented policies for returns, refunds, and cancellations could turn a potentially negative experience into an opportunity to build trust and loyalty.

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3. Establish a Digital Presence

You can use the internet to give potential customers opportunities to find your business and buy your services or products. This is one of the key business growth strategies.

Social media is a free and easy method for providing information on your business and engaging with customers. You can use platforms like Facebook and Instagram to target marketing campaigns by geographic location, age, or other demographics.

If your business has a website or blog, search engine optimization (SEO) is another way you could enhance your business’s digital presence. SEO tactics can help your site or posts rank higher on search engines like Google or Bing. Including meta descriptions, header tags, and keywords are some leading SEO strategies. Alternatively, joining popular sites like Yelp or Tripadvisor could increase your business’s SEO.

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4. Expand Locations

If you’ve outgrown your current location or you’re looking to add a new workspace or storefront to reach untapped markets, now may be a good time to expand your physical presence. But before you take the leap to rent or buy real estate, there are some important considerations to think through.

Where your business is located can have multiple impacts, including the talent pool you can draw from, the size of your customer base, as well as the cost of doing business.

To identify a suitable site for expansion, you’ll want to look at factors that make your current location successful, such as customer traffic, adjacent attractions, and population demographics. Evaluating a potential property for its ability to accommodate current and future needs could help you set your business up for long-term growth.

Assessing the competition is another key step when you’re approaching expansion. While rival businesses may pose challenges, they could also provide an opportunity to grow through acquisition. While it may require a significant investment, buying another enterprise with a proven business model and existing brand can let you bypass the time-consuming phase of starting a small business and allow you to generate cash flow and revenue sooner.

As the Baby Boomer generation continues to approach retirement, many will likely be looking to sell their long-running small businesses. This trend represents an opportunity for younger entrepreneurs to take the reins. Business transition planning can take time, so starting the conversation early could be beneficial.

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5. Make Acquisitions

You may feel it’s time to acquire an existing company in order to expand. A small business loan that helps you buy a pre-existing business or franchise (or buy out partners of your current business) is called a business acquisition loan.

If the acquisition seems to make sense for you or your current company, financing the arrangement can speed up the process of starting your new venture. Small business franchise loans are another area to explore.

Make the best decision for your situation by learning how business acquisition loans work and what you’ll need to apply for one.

Recommended: What Is Inorganic Growth?

6. Empower Your Team

When evaluating business growth strategies, it’s important to consider not just external resources but also internal growth opportunities. The people who work at your business, whether they’re employees or partners, are also integral to your business’s success.

Employee turnover can be a hindrance to growing your business. The time and effort spent rehiring and onboarding new workers can come at a cost to productivity and profit. Finding ways to engage employees could increase retention and create a positive and healthy workplace culture. Helpful strategies include professional development opportunities, encouraging coworker mentorship, and redesigning an office layout to reflect your workers’ wants and needs.

A more empowered and fulfilled workforce could translate to improved customer service and job performance outcomes.

While employee engagement strategies can vary, providing avenues for both one-on-one communication and anonymous feedback may help build trust and obtain more candid feedback.

7. Network

Business networking involves meeting other businesspeople, including entrepreneurs representing competitors, potential partners, and mentors. Any and all of these people might help inform how to grow your business.

As a business owner, getting a fresh perspective from peers can provide valuable insight and opportunities to test-run your products and business growth ideas. Networking is also a chance to gain knowledge about industry best practices in areas like sales, supply chain, and marketing. If financing is key to growing your business, networking may also be a way to meet potential investors or partners for your venture.

To help you decide which groups or events are worth your limited time as a business owner, consider who you want to meet and what you want to gain. Following up on any contacts you make with a personalized note and invitation to continue the conversation could help you translate a lead into a relationship.

In addition to one-off events, consider joining a professional association or the local chamber of commerce. These groups offer opportunities for long-term networking and relationship building.

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8. Redevelop Your Business Plan

There are plenty of growth options available to small businesses. But coordinating efforts to sustain changes long-term can be challenging.

A small business plan can help you organize strategies within your business structure and provide a roadmap for how to grow your business.

One thing the pandemic taught us is the importance of planning for the unexpected. A strong business plan can prepare your small business for different scenarios and obstacles you may encounter in the pursuit of your goals.

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9. Be Adaptable

A business plan can serve as a guide for business growth, but it can’t account for every contingency and situation. As technology, regulation, and competition in the market evolve, your business may need to adapt its organizational structure to stay afloat and on track for its growth goals.

Unforeseen opportunities for growing your business may arise along the way, and being flexible to act on them quickly could be a difference maker.

Recommended: 6 Tips for Making a Financial Plan

10. Consider International Expansion

Global markets can look very appealing. But this sort of growth requires careful planning and shrewd timing if you want to capitalize on such opportunities.

This one can be a challenge. If you wait too long, your competitor may beat you to the international punch. But if you expand too early, you may put your existing domestic business at financial risk.

If you’re thinking about going global, it’s a good idea to come up with a concrete business plan for the expansion, just as you did when founding your business. Explore potential target markets, consider marketing and regulatory costs, and investigate potential suppliers and distribution channels.

The Takeaway

There’s no one universal approach to finding success and business growth in 2024. Good strategies for how to grow a small business will likely differ from those that work for a mid-size or large company. It’s important to determine which strategies align with your resources, target audience, type of business, and goals.

As your business evolves, keep in mind that what worked to get it off the ground may not work as well for your next stage of growth. Referring back to your business plan can help you track progress and make changes as needed.

If you’re seeking financing for your business, SoFi can help. On SoFi’s marketplace, you can shop top providers today to access the capital you need. Find a personalized business financing option today in minutes.

Photo credit: iStock/SeventyFour

SoFi's marketplace is owned and operated by SoFi Lending Corp. See SoFi Lending Corp. licensing information below. Advertising Disclosures: SoFi receives compensation in the event you obtain a loan through SoFi’s marketplace. This affects whether a product or service is featured on this site and could affect the order of presentation. SoFi does not include all products and services in the market. All rates, terms, and conditions vary by provider.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.

SOSB0424067

Just like for-profit businesses, nonprofits need capital to buy equipment, pay employees, build infrastructure, and fund their projects. However, when it comes to getting financing, nonprofits often face more hurdles than traditional businesses do.

Fortunately, options for nonprofit business loans are out there. The key to finding the right financing for your organization is knowing where to look.

Key Points

•   Nonprofit business loans are similar to for-profit business loans. To qualify for any business loan, you’ll need to meet the lender’s requirements, regardless of whether your business is for-profit or not-for-profit.

•   Nonprofit loans are often viewed as risky to the lender. Because of this, you may have to meet a certain credit requirement and/or put up collateral to secure the loan.

•   Funding options for nonprofits include loans, grants, corporate giving programs, crowdfunding sites, and more.

•   Nonprofit organizations can also apply for small business lines of credit and business credit cards when in need of funds.

What Are Nonprofit Business Loans?

A nonprofit business loan is similar to any type of small business loan except that it’s made available to a not-for-profit organization. These types of loans are often available through lenders and organizations that are themselves nonprofit. Some banks, credit unions, and online lenders are able to provide loans to nonprofit businesses.

How Do Nonprofit Business Loans Work?

Like any business loan, nonprofit business loans often have a lengthy application and approval process. This is done to ensure the organization actually has the monthly cash flow to easily pay upon a new debt.

With a nonprofit term loan, your charity would receive the full amount of the loan (known as the principal) up front, then have a period of time — which could be anywhere from a few months to 25 years — to pay it back (with interest and fees added), typically in monthly installments.

As you explore business loans for your organization, it’s important to read the fine print. You’ll want to know the repayment terms, interest rates, fees, and if collateral or a personal guarantee is required. Keep in mind that longer repayment terms carry lower monthly payments, but could actually cost more in the long run as interest accrues.

Pros and Cons of Using Loans for Nonprofit Organizations

Taking out a loan in the name of your nonprofit can expedite the growth of your organization, allow you to better market your cause, fund new projects, hire more staff, and ease any cash flow issues. And, if you can find a nonprofit lender, you may be able to get financing with a low interest rate and favorable terms.

However, a nonprofit business loan can take some time and effort to find, apply for, and get funding from. In addition, interest rates from a traditional lender may be high, since they often see nonprofits as higher risk. The lender may also require collateral, which could be seized if you fail to make payments.

Why Are Nonprofit Business Loans Difficult to Obtain?

Getting a small business loan is often a lot easier than getting a nonprofit loan. For one reason, there aren’t as many nonprofit business loans available as there are traditional small business loans. Below are some of the obstacles your organization may face when seeking financing.

Strict Requirements

Lenders are in the business of getting their loans repaid, so before lending to a nonprofit, they will likely want to see strong revenue and cash flow. A nonprofit that has consistent and solid cash flow is more likely to pay upon its debts and less likely to default in the future. Nonprofits that are operating at a loss may find it especially hard to qualify for some loans.

Risky Investment

When lenders give a loan to a small business, they assume that the funds will increase profits in some way. However, it’s more difficult for a nonprofit to bring in revenue than a traditional small business.

For businesses, small gambles like increasing services can help bring in more cash flow. But when a nonprofit does this, it’s spending more money without any guarantee that charitable donations will increase. This doesn’t necessarily mean that you can’t get capital from traditional sources, but it can mean higher interest rates on any loans you secure for your nonprofit organization.

Collateral Is Often Required

As a nonprofit, a lender will likely require collateral to help mitigate their risk. When a loan is secured with collateral, a lender knows it will be able to recoup most or all of their money even if the borrower defaults on payments by seizing and selling the collateral.

This can be a tricky requirement for nonprofits to navigate, since they may not have valuable assets that can help them secure a loan. The difference between secured vs. unsecured loans is that secured loans (with collateral) tend to come with much lower interest rates than unsecured loans (without collateral).

Typical Funding Options for Nonprofit Businesses

Despite the potential difficulties, there are many funding options available to nonprofits. Here are some you may want to explore.

SBA Loans and Grants

Loans backed by the U.S. Small business Administration (SBA) are not typically available to nonprofits. However, the SBA provides grants to nonprofit organizations dedicated to helping underprivileged individuals or communities through their Program for Investment in Micro-Entrepreneurs (PRIME).

Nonprofit Loan Funds

There are some lenders that focus exclusively on loaning money to nonprofits. In many cases, these lenders are nonprofits themselves with a mission to help underserved communities. While there aren’t many options out there, nonprofit loan funds often come with low (and sometimes even zero) interest rates and attractive terms. You may want to start your search with Nonprofit Finance Fund and Propel Nonprofits to see if this might be a good fit for your charity.

Nonprofit Grants

Grants can be a major source of funding for nonprofits. Grants for nonprofits are often available from government agencies, business associations, corporations, or other nonprofit organizations. The upside of grants vs. loans is that the money does not have to be repaid. However, grant money sometimes needs to be used for a specific purpose and competition for these awards can be stiff.

When searching for grants, you can check Grants.gov, which is the largest database of federal grant opportunities. You may also want to look locally, as many grants targeted for nonprofits are offered at the state and local level.

CDFIs

The Community Development Financial Institutions Fund (CDFI Fund), which is part of the U.S. Treasury, gives funds to lenders focused on providing financial assistance to businesses and organizations that serve disadvantaged areas. These lenders, known as “CDFIs,” typically don’t operate at the national level, but you can reach out to local banks and nonprofit groups that have received CDFI funds to discuss low-cost business loans for nonprofits.

Corporate Giving Programs

A corporate giving program (CGP) is a program in which a business donates gifts, cash, or organizes fundraising campaigns to help a cause it believes in. While a CGP may not become a major source of funding for your nonprofit, it can be worthwhile to appeal to local small businesses and corporations who want to give back to the community. You may be surprised by how many companies want to offer their support.

Crowdfunding Sites

Crowdfunding is another way you may be able to raise capital for your nonprofit. Rather than securing a large lump sum from a loan or grant, crowdfunding focuses on collecting smaller amounts from a large number of people. Depending on the crowdfunding platform you use, you may be able to get free money (in the form of online donations) or a no-interest crowdfunded loan, which means you’ll only have to repay the principal on the loan.

Applying for Nonprofit Business Loans

Once you find a loan that may work for your organization, you’ll want to start preparing your application. The process will vary with each lender, but here’s how to get started.

Read the qualification requirements carefully. Nonprofit loans are a very specific type of financing, so you’ll want to make sure your nonprofit meets all the minimum requirements to avoid wasting time.

Write a strong business plan. Just like a for-profit business, nonprofits need to have a solid business plan in place when applying for financing. The lender will likely want to see details about how your nonprofit meets a need in the community, along with how you plan to use proceeds from a loan, including supporting research and financial documentation. They’ll also want to see that your organization can successfully raise funds.

Gather your documents. Whether you’re applying for a loan or a grant, you will likely be asked to submit a fair amount of paperwork. This may include:

•   Your organization’s fundraising case statement

•   Proof of 501(c)(3) (nonprofit/tax-exempt) status

•   Recent tax returns

•   Recent bank statements

•   Other financial documents (e.g., income reports, cash flow projections)

•   Proof of collateral

Recommended: Starting a Minority Woman Owned Business

Alternative Funding Options for Nonprofits

Besides the loans and grants listed above, you may want to investigate these other sources of business and nonprofit funding.

Online Loans

There are various types of online business loans that your nonprofit may be eligible for. Typically, online loans have more relaxed requirements and are much faster to fund than bank loans. However, they often come with higher interest rates.

Banks or Credit Unions

If you have a very strong credit history and your nonprofit is generating revenue, it may be worth applying for a loan through your local bank or credit union. Just make sure that the bank or credit union lends to nonprofits. Also keep in mind that interest rates from traditional lenders may be higher for a nonprofit than a for-profit business, due to higher risk.

Business Credit Card

With some research, you may be able to find business credit cards with low interest rates. Some cards even offer a 0% introductory APR (which may last as long as 21 months). This might allow you to cover an unusually high expense, then pay the card off before the usual interest rate kicks in.

Business Line of Credit

It may be possible for your nonprofit to qualify for a business line of credit, which is a pre-approved amount of money that you can access at any time and for any reason. You only pay interest on the money you actually borrow.

Recommended: Nonprofit vs. Foundation

Nonprofit Lenders

Nonprofit lenders can be a good source of funding for a charity.

What Nonprofit Lenders Are

A nonprofit lender is one that focuses on lending to nonprofits and mission-based small businesses in their community that have the potential to provide an economic impact. In addition to funds, nonprofit lenders also often offer training, education, and other resources to help nonprofits and small businesses make the right decisions for their development and longevity.

How Nonprofit Lenders Work

Many nonprofit lenders focus on offering smaller loans (typically $50,000 or less). While the application and underwriting process can often be involved and time-consuming, these lenders often offer low interest rates to organizations unable to access capital from traditional sources.

How to Find Nonprofit Lenders

Your local Small Business Development Center (SBDC) or SCORE office (a resource partner of the SBA) may be able to help you identify local nonprofit lenders. You can find these offices, as well as other helpful resources, using the SBA’s search tool.

Recommended: Guide to Grant Writing for Small Businesses

The Takeaway

It’s possible to find a business loan for a nonprofit organization, but it can take a bit of time and legwork.

If you’re seeking financing for your business, SoFi can help. On SoFi’s marketplace, you can shop top providers today to access the capital you need. Find a personalized business financing option today in minutes.

FAQ

Can you get a business loan for a nonprofit?

Yes. Many traditional lenders, however, see nonprofits as risky and may charge a higher interest rate.

Does SBA give loans to nonprofits?

Not typically, but they do offer grants to nonprofits. To get a loan as a nonprofit, you can apply with banks, credit unions, and online lenders. Online lenders tend to have less stringent income and credit requirements, but may charge higher interest rates and more fees.

Do nonprofits have a credit score?

Yes, nonprofits can establish a credit history and build a credit score by getting a D-U-N-S Number, along with a bank account and credit card in the organization’s name.

Can a nonprofit be a small business?

No, to meet the definition of a small business, you must be organized for profit. A 501(c)3 is not organized for profit, so it does not qualify as a small business.

Photo credit: iStock/FG Trade

SoFi's marketplace is owned and operated by SoFi Lending Corp. See SoFi Lending Corp. licensing information below. Advertising Disclosures: SoFi receives compensation in the event you obtain a loan through SoFi’s marketplace. This affects whether a product or service is featured on this site and could affect the order of presentation. SoFi does not include all products and services in the market. All rates, terms, and conditions vary by provider.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

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Accounts receivable factoring, also known as invoice factoring or business receivable factoring, is a method of business financing that companies sometimes use to help manage cash flow and meet expenses. Factoring receivables involves a different process than taking out a bank loan, but the general goal for both is often the same: to provide the business with needed cash.

For clarity, a factoring company or factor is a lender that provides financing through the invoice factoring process. In other words, the lender gives the small business financing in exchange for unpaid invoices.

Learn more on what accounts receivable factoring is, pros and cons of this type of financing, and alternatives you may want to consider.

What Is Accounts Receivable Factoring?

Factoring accounts receivable is a method of financing that B2B companies that invoice their customers and vendors could consider when they’re in need of quick cash. Basically, the business gets a loan from a factoring company using its accounts receivables as security.

Typically, the factoring company will give the business a percentage of its outstanding invoices (the advance percentage, which is typically around 80%). When the invoices are paid by the customers, the factoring company gives the remaining 20% to the business, minus any factoring fees (which can be high).

Recommended: What Are Accounts Payable?

How Does Factoring Accounts Receivable Work?

Here’s a basic illustration to show how accounts receivable factoring works.

Let’s say that your business has issued $20,000 in invoices that haven’t been paid yet. Let’s also say that your business will be $10,000 short in meeting payroll if those payments aren’t made on time.

To address the situation, your business might decide to factor receivables in order to get enough cash in to pay your employees. This would involve selling the unpaid invoices to a third-party factoring company (or “factor”).

At this point, the factor would own the invoices and your business would receive a certain percentage of the dollar amount on them. This is called the “advance rate.” The advance rate that your business would receive would be based on how risky the transaction is for the factoring company.

The difference between the dollar amount on the invoice and the amount your business gets upfront is held in reserve until the invoices are paid. Once your customers have paid, the remainder is forwarded to your business, minus the factoring fee.

Factoring Accounts Receivable Example

To give some numbers to the example, let’s say that your business qualifies for an advance rate of 80%. To meet payroll expenses of $10,000, you decide to factor $15,000 out of your $20,000 in outstanding receivables.

The factoring company would then issue you 80% of the value of the receivables being factored ($15,000 x 80%): $12,000. You could then use $10,000 of the funds to pay your employees and have $2,000 left over for miscellaneous expenses.

The next step is for your customers to pay their invoices in full (that money goes to the factor, not directly to your business). Once paid, the factoring company will release the reserve amount (in our example, 20% of the invoice amount, or $3,000) minus the factoring fee charged by that particular factor.

How Are Factor Fees Calculated?

A factor may consider a number of things to determine what factor fee to charge your business. It might look at the industry your business is in, how many invoices are involved, your customers’ payment histories, and your company’s financials to determine what factor fee to charge you.

That said, typically these fees run from 1% to 3% of your invoices, but may go as high as 5%.

Bear in mind that you might have to pay a flat factor fee for each week that an invoice goes unpaid — 2% the first week, 2% the second week, and so on. But some factors charge a tiered factoring fee, meaning that the amount of your fee can go up if the invoice isn’t paid right away. So while the factor fee might be 2% the first week, it might rise to 3% the next week.

Recommended: Business Cash Management: Tips for Managing Cash

How to Qualify for Accounts Receivable Factoring

Qualifications for accounts receivable financing are much less stringent than for other types of small business financing, such as small business loans or business lines of credit.

With accounts receivable financing, the invoices serve as collateral, making it an attractive form of borrowing for businesses without strong credit histories. To qualify, you simply need to have outstanding invoices from reliable customers. The factoring company will look at the credit history of your customers as opposed to your business.

Recommended: Business Loans Based on Revenue

Pros and Cons of Accounts Receivable Factoring

Even companies that focus on cash management strategies sometimes need an influx of cash — and, for some of them, invoice factoring can be a good solution. Just as with other forms of small business financing, though, there are pros and cons to accounts receivable factoring.

Advantages of Accounts Receivable Factoring

Benefits may include the following:

•   No collateral is required, other than the invoices.

•   You can typically access the cash quickly.

•   Factoring can help your business manage cash flow.

•   Lenders typically focus less on the business’s or owner’s credit score and more on the creditworthiness of the customers owing on the invoices.

•   Some factors will work with startups.

•   Funds provided by a factor can typically be spent in any way the business desires, with no restrictions.

•   The factor company takes over collecting on the invoices, freeing up your business to handle other tasks.

Disadvantages of Accounts Receivable Factoring

Cons of accounts receivable factoring can include the following:

•   Rates can be relatively high. Plus, there can be a variety of fees, including application, processing, and service fees, which means that factoring can be a more expensive way of getting business funding. This can be especially true if the invoiced customers don’t pay on time.

•   The factoring company has control of the invoices after your business sells them. That’s why it’s important to choose a factor that will treat your customers fairly and with respect.

•   If customers don’t pay the invoices that were factored, your business may need to pay for those invoices, along with added fees.

•   If a business’s customers aren’t creditworthy, then it may be difficult to factor accounts receivable from them.

•   What a factor charges will depend on the creditworthiness of the invoiced customers, how old the invoices being factored are, the invoice due dates, and more. Just as with banks that make loans, it’s important to compare what different factoring companies would charge.

Recommended: Types of Small Business Loan Fees

Accounts Receivable Factoring vs Accounts Receivable Financing

Accounts receivable factoring gives the lender full control of the unpaid invoices. Your business no longer owns them; instead, the factoring company does. With accounts receivable financing, on the other hand, your business still owns the unpaid invoices.

To qualify for accounts receivable financing, or invoice financing, your credit score and financial history are taken into consideration. With accounts receivable factoring, it’s the credit history of your customers that’s taken into account.

Recourse Versus Non-Recourse

These are two different factoring models: recourse and non-recourse.

When a factor uses a recourse approach, this means that a company would be responsible for any factored invoices that its customers didn’t pay.

When factors are using a non-recourse approach, the factoring company is responsible for any unpaid invoices. There can be exceptions to this rule if certain conditions are met, though. For example, if an invoiced customer files for bankruptcy within a defined window of time or goes out of business, the business might not be held responsible for its invoices. Non-recourse factoring companies may charge a higher fee because they’re taking on more risk.

Recommended: What Is Traditional Income Statements Explained

Choosing the Right Factoring Company

Just as with any lender, you should check out factoring companies that you might want to work with carefully to make sure they’re trustworthy.

•   Is it registered in your state?

•   Does it have good reviews online?

•   What is its Better Business Bureau ranking?

•   Does it specialize in specific industries? (Some factoring companies work with very specific industries, such as medical or freight transport, while others are more general.)

•   What are its rates and advance percentages?

•   Is there a minimum number of factoring transactions required each month?

•   If there are no minimum requirements, will factoring a certain amount of invoices each month provide your company with a discount?

Once you settle on a factoring company, the factor will then conduct due diligence on your business and on the customers whose invoices may be factored.

After that review is satisfactorily completed, the factoring company will offer an agreement that should be carefully reviewed. Check the interest rate and fees, including whether there is a cancellation fee. See if any minimum factoring amounts are listed, whether there’s a contract term that you’re agreeing to, and so forth.

Alternatives to Accounts Receivable Factoring

While accounts receivable factoring is one way to get cash for your business, there are other ways, too.

Free Up Cash Flow: Ways to free up cash flow include cutting expenses, increasing pricing, and turning invoices into cash more quickly, perhaps by offering early pay discounts to customers and/or asking for a deposit when orders are made.

Business Line of Credit: Getting a business line of credit from a bank or online lender gives you access to a certain amount of funding decided upon by the lender that you can draw on at will. Interest is charged only on unpaid balances. Business lines of credit are typically revolving credit that replenish how much you can draw as you pay back whatever you owe.

Online Business Loan: Online lenders frequently provide loan options similar to those of a traditional bank. However, typically online lenders have a faster approval process. What’s more, they may offer more options for business owners with lower credit scores.

The Takeaway

Accounts receivable factoring is a method of small business financing where you sell your invoices to a factoring company. You receive a percentage of the invoices upfront, and the remaining amount (minus any fees) when the invoice is paid in full. However, depending on your situation, accounts receivable factoring may not be the best type of financing for your small business. Other options include traditional small business loans, small business lines of credit, and SBA loans.

If you’re seeking financing for your business, SoFi can help. On SoFi’s marketplace, you can shop top providers today to access the capital you need. Find a personalized business financing option today in minutes.

FAQ

What is accounts receivable factoring?

Accounts receivable factoring is a type of small business financing where you sell your unpaid invoices to a factoring company. You receive a percentage of the invoices immediately, and once the customer pays the invoice, you receive the rest, minus any fees (which can be expensive).

How do you calculate AR factoring?

Accounts receivable factoring is calculated by first determining eligible invoices. Ideal invoices are no more than 90 days late and are owned by creditworthy customers. Then, the factoring company will determine how much of the invoice they’ll give you — typically 80-90% of the invoice total. Once the customer pays the invoice, the factoring company will give you the remaining percentage, minus any fees.

Photo credit: iStock/Thapana Onphalai

SoFi's marketplace is owned and operated by SoFi Lending Corp. See SoFi Lending Corp. licensing information below. Advertising Disclosures: SoFi receives compensation in the event you obtain a loan through SoFi’s marketplace. This affects whether a product or service is featured on this site and could affect the order of presentation. SoFi does not include all products and services in the market. All rates, terms, and conditions vary by provider.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

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