SoFi

Once your small business starts earning a profit, you have to decide if you should distribute those profits to yourself (and any other owners) or reinvest them back into the business.

While it can be tempting to pocket your company’s profits, funneling at least some of that money back into the business is worth considering.

For one, reinvesting can help improve the company or expand operations, leading to even higher profits down the line. For another, reinvested money is generally considered a business expense, which means you likely won’t have to pay income taxes on it.

Read on for a closer look at why you may want to reinvest a percentage of your profits back into your business, how this can impact your business taxes, and ways you might use profits to help expedite business growth.

What Constitutes a Business Profit?

Profit is the money a business pulls in after accounting for all expenses. Any profits earned funnel back to business owners, who can choose to either keep it as earnings, distribute it to shareholders as dividends, or reinvest it back into the business.

Whether you own a small dog grooming business or a multinational corporation, the main goal of any business is to earn money. Thus, a business’s performance is based on profitability. For accounting purposes, companies will often report gross profit, operating profit, and net profit (the “bottom line”).

Recommended: How to Read Financial Statements: The Basics

What Are Businesses Taxed On?

Any profits that aren’t reinvested in a business are typically taxed as income. How that tax is paid depends on the structure of the business.

Most small businesses are pass-through entities, which means that the gains or losses are passed through to the owners on their personal income tax returns. Corporations, on the other hand, pay a flat tax on business profits.

Recommended: 10 Steps to Starting a Small Business

Types of Business Taxes

When we refer to “taxes” for a business, we’re actually using an umbrella term for many different types of taxes a business may have to pay. Let’s take a closer look.

Income Taxes

Income taxes are based on the net income of your business for the tax year. Net income is the same thing as profit (income minus expenses). If you share a business with others, the net income is divided among the owners based on your business agreement. Most small businesses pay both federal and state income taxes.

Estimated Taxes

Employees have taxes withheld from their paychecks, but as the owner of your business, no one is withholding taxes from the money you take out of the business.

Instead, you need to file estimated taxes throughout the year based on the income you have earned up to that point in the year. Typically, federal and state estimated tax payments are due on April 15, June 15, September 15, and January 15 for the previous tax year.

Self-Employment Tax

Employees generally have Social Security and Medicare taxes withheld from their paychecks. If you are a self-employed business owner, however, you must calculate and pay your own Medicare and Social Security tax through self-employment taxes.

Excise and Sales Taxes

Depending on which state you operate in and what type of goods or service you sell, you may need to set up a system to collect sales tax from your customers and report and pay that tax to your state.

You may also need to pay federal and local excise taxes. An excise tax is a legislated tax on specific goods or services, such as fuel, tobacco, and alcohol.

Payroll Taxes

If you have employees, you must withhold payroll taxes from their paychecks and pay applicable federal, state, and local taxes. The taxes usually withheld from employee paychecks include FICA (Medicare and Social Security taxes) and federal, state, and local income taxes. Employers and employees each pay half of the FICA tax.

Recommended: 3-Year Business Plan Structure

How to Reduce Taxable Income

As a business owner, there are many strategies you can use to reduce the portion of your business income (or profits) that can be taxed. Here are some you may want to consider.

Reinvesting Business Profits Into the Business

Reinvesting means retaining net profits (the income left over after all operating costs and overhead are paid) and investing them in activities or expenses that can help increase the value of the business. As a business expense, reinvested income generally isn’t taxable.

You may, however, want to reinvest only a portion of your profits and look for other ways to infuse capital into the business, such as applying for a small business loan. Interest paid on business loans is typically tax deductible as a business expense.

Finding Deductions

There are numerous business tax deductions you may qualify for and, when you add them all up, they can amount to a significant reduction in your taxable business income. Here are some of the most common small business deductions:

•  Inventory

•  Business property rent

•  Startup costs

•  Utilities

•  Company vehicle expenses

•  Insurance

•  Rent and depreciation on equipment and machinery

•  Office supplies

•  Furniture

•  Advertising and marketing

•  Business entertainment

•  Travel expenses

•  Interest paid on all types of small business loans

Tax Audits

As a small business owner, it makes financial sense to explore all your options for reducing your tax bill. However, when it comes to deductions, you need to be careful. It’s particularly important, for example, to keep your business and personal expenses separate. If your deductions look suspicious to the IRS, the agency could potentially audit your business.

Investing in Employees

One great way to reduce your company’s taxable income is to invest in your employees. Generally speaking, any wages, bonuses, or other compensation you pay your workers in a given year are tax deductible as a business expense. That includes any fringe benefits you offer — such as gifts, health plans, and employee discounts — as well.

Rewarding your workforce can do more than lower your tax liability, however. It can also help boost their morale, increase productivity, attract the top talent, and grow your business.

Choosing Purchases and Investments Wisely

While it’s clearly important to invest in your business, the question remains: Where should you focus your funds? Here are a few purchases and investments you may want to consider.

•  Equipment: It can be smart to reinvest profits into new machinery and equipment as your current assets age and become expensive to maintain. Upgrading equipment can increase efficiency and help you stay on the cutting edge of your industry.

•  Software: Investing in software, such as payroll and accounting software, can help streamline tedious tasks and free you up to focus on more important matters, such as growing your business.

•  Inventory: In some cases, using business profits to buy more inventory can be a smart business move. If you often sell out of popular products, for example, beefing up inventory can help you capture sales you’ve been missing out on.

•  More marketing: You might consider hiring a marketing professional or agency to help create buzz about your business, improve search rankings, and expand your customer base.

Recommended: Business Cash Management, Explained

Tax Planning Strategies

One of the best ways to make your business tax efficient is to pay attention to tax credits and not just deductions.

Tax credits are particularly valuable because, unlike deductions, which reduce your taxable income, credits reduce your tax bill on a dollar-for-dollar basis. For example, if your small business owes $25,000 in taxes, a $5,000 tax credit means you can subtract $5,000 from your tax bill and only owe $20,000.

There are a number of tax credits your business might qualify for, including:

•  Credit for Small-Business Health Insurance Premiums

•  Employer Credit for Paid Family and Medical Leave

•  Work Opportunity Credit

•  Credit for Increasing Research Activities

•  Disabled Access Credit

•  Credit for Employer-Provided Childcare Facilities and Services

•  New markets credit

The Takeaway

It takes hard work to establish and grow your business. Once you’re able to cover all your expenses, pay yourself a salary, and still have money left on the table, it may be time to consider putting that extra money into your business.

Reinvestment means pouring a percentage of your company’s profits back into your business. It can be a great way to increase the value of your company and to help your company grow. What’s more, reinvesting can reduce your business tax liability at the end of the year, for the ultimate win-win.

If you’re seeking financing for your business, SoFi is here to support you. On SoFi’s marketplace, you can shop and compare financing options for your business in minutes.

FAQ

How much is a small business able to make before paying taxes?

A small business generally must pay taxes on any profit it earns, but the specific amount before paying taxes depends on deductions, credits, and the business structure. For self-employed individuals, income over $400 is subject to self-employment tax, while other tax obligations vary by income and state laws.

What does the 20% business tax deduction do?

The 20% business tax deduction, part of the Qualified Business Income (QBI) deduction, allows eligible small businesses to deduct up to 20% of their qualified business income from their taxable income. This reduces their overall tax liability, promoting business growth and investment.

What is a business write-off?

A business write-off is a tax deduction that allows businesses to subtract certain eligible expenses from their taxable income. Common write-offs include operating costs, rent, supplies, meals, startup expenses, employee salaries, and more. These deductions reduce the overall tax liability by lowering the business’s reported income.

Can you invest business profits to avoid taxes?

Yes, you can reinvest business profits into the company to reduce taxable income, but you cannot avoid taxes as a small business owner. While reinvesting can lower taxes, it doesn’t fully eliminate tax obligations, as profits are still subject to applicable tax laws and limits.

Photo credit: iStock/Andrii Yalanskyi

SoFi's marketplace is owned and operated by SoFi Lending Corp.
Advertising Disclosures: The preliminary options presented on this site are from lenders and providers that pay SoFi compensation for marketing their products and services. This affects whether a product or service is presented on this site. SoFi does not include all products and services in the market. All rates, terms, and conditions vary by provider. See SoFi Lending Corp. licensing information below.

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.

SOSMB-Q324-032

For the 33.2 million small business owners in America, a good night’s rest may be hard to come by.

Many entrepreneurs struggle with cash flow, but today’s higher prices and interest rates can make keeping the business on track, not to mention securing a business loan, pretty challenging. Those worries hit hard at night, with 85% of small business owners saying they are losing sleep over financing, according to a recent survey of owners conducted for SoFi.

“Almost every day there is a constant worry about funding,” said Amy Wampler, CEO at Spartan Mechanical in Bedford, Indiana. “I find it hard to sleep at night because of the issue of managing cash flow. It is so stressful that, during off-seasons, I might not have enough money to cover all our bills.”

America says it loves small business. When asked about their views on U.S. institutions, an overwhelming portion of Americans (86%) have positive views of small businesses, according to the findings of a 2024 PEW Research Center study.

But what the admirers may fail to realize is this is not always an easy path for the owners, especially in recent years. In our survey, 25% of the entrepreneurs say they are dissatisfied with the current financial situation of their small business.

When Small Business Owners Are Searching for Loans: An Interesting Trend

“To put it frankly, small businesses have to do the same things corporations do to stay afloat, but with a fraction of the budget and team,” said Brooke Webber, head of marketing and executive team member at Ninja Patches. “This dilemma is part of what keeps me up at night.”

Our analysis of small-business-owners’ nocturnal stress began with data spotted on Google Trends. We looked at searches for “small business loans” and were struck with the fact that it peaked in the middle of the night. Not only did we see that middle-of-the-night anxiety hits hard, we discovered precisely when it hits hardest.

Based on data gathered from Google Trends for more than 120 days between October 2023 and April 2024, the average peak search interest for “small business loan” was at 4:50 AM Central Time.

This surprising revelation led us to dig deeper into the question: Why are small business owners searching for small business loan information in the wee hours of the morning?

Small Business Owner Concerns

According to the Small Business Administration (SBA) Office of Advocacy, a small business is an independent business having fewer than 500 employees. Over the last ten years, those small businesses have employed an average of 46% of the country’s workforce.

But the stakes are high. The Bureau of Labor Statistics says that approximately 20% of new businesses fail within the first two years of operation.

For our research on small business challenges, we heard from 1,000 adults (18+) in the U.S. who were owners or partners of a business employing 50 people or less.

In the survey, the respondents said these issues keep them up at night (more than one response was possible):

•   41%: Cash flow management

•   40%: Competition in the market

•   38%: Marketing and customer acquisition

•   21%: Employee-related concerns

•   17%: Regulatory compliance*

But more than anything else, it seems that financing questions make people turn on their computers or smartphones at night. Half of small business owners said they search online for information about small business loans at least monthly, according to our survey. And 30% said they search online for this info at least weekly.

* We rounded percentages to the nearest whole number, so some data sets may not add up exactly to 100%.

Concerns for Funding and Capital

New small business owners often need to borrow money to buy equipment and supplies, pay employees, and otherwise finance their operations. In our survey, about three out of four small business owners said they have some level of concern about securing funding for their business, and 18% said they are “very concerned.”

When we asked which was the primary worry about small business funding they dealt with, the answers broke down this way:

•   38%: Insufficient capital for growth

•   30%: High interest rates

•   15%: Fear of rejection

•   11%: Complex loan application process

“As a bootstrapped business, I frequently worry about funding, especially during critical phases of development,” said Axel Lavergne, Founder of Review Flowz. “The most troubling aspect is ensuring we have sufficient cash flow to cover operational expenses, development costs, and marketing efforts without external financial backing.”

Recommended: Mompreneurs in 2024: Generational Wealth and Real-Life Struggles

Sourcing and Applying for Loans

In our survey, 40% of small business owners said they’ve applied for a small business loan.

For some of them, getting a loan was a game changer.

“It was quite the journey—wading through the sea of paperwork and convincing the powers-that-be of our growth potential,” said Eugene Klimaszewski, Founder of Mammoth Security Inc.“ “But in the end, it paid off. We were able to funnel those funds into state-of-the-art security systems, giving our services a serious upgrade.”

For those who said they had difficulty seeking financing, the obstacles ranged from the entrepreneurs saying the lenders didn’t understand their business to the complexity of the loan process. One respondent said, “I applied for an SBA loan, and the process was so cumbersome that I again opted to personally fund.”

Here’s how the challenges break down when we asked respondents what problems they faced during the loan application process (responses given by the 40% who’ve applied for a loan and more than one choice was possible):

•   47%: revenue or asset amount requirements

•   40%: Credit score issues

•   40%: Lengthy approval times

•   39%: Documentation requirements

•   33%: Business maturity (length of time business has been in operation)

•   31%: Lack of transparency in terms and conditions

Recommended: 15 Types of Small Business Loans

Alternative Funding Options

Owners often find alternatives to small business loans to boost their company, whether it’s microloans, family help, or investors.

In our survey, one-third of small business owners (33%) said they have explored alternative funding options like crowdfunding or peer-to-peer lending. Of those, less than half (41%) have found a suitable option. And another one-third (33%) haven’t explored alternative options, but said that they plan to.

When Businesses Suffer

A lack of funding has caused some business owners to cancel or delay certain business initiatives, according to our survey.

When asked which initiatives they had to put a stop to or push back because of lack of funding, the owners said:

•   39%: Business expansion

•   39% Purchasing assets

•   36% Marketing

•   28% Hiring employees

•   18% Research and development

•   13% Acquisitions or partnerships

•   13% Meeting compliance standards

“The real crunch is making sure we’ve got the funds to stay ahead and make waves in the
fast-paced gaming world, said Marin Christian-Ovidiu, CEO of Online Games. “The price tag for creating and releasing a new game is hefty, and any hiccup in financing can throw off our schedules and put us behind in the race.”

Recommended: Unemployment Rates by City

The Takeaway

After seeing that on Google Trends the average peak search interest for “small business loan” was at 4:50 AM Central Time, we surveyed 1,000 small business owners and found that 85% say they are losing sleep over worries about financing.

In the survey on small business challenges, when asked which was the primary worry about small business funding they dealt with, the answers broke down this way: Insufficient capital for growth (38%), high interest rates: (30%), fear of rejection (15%), and complex loan application process (11%).

If you’re seeking financing for your small 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.

If you’re seeking financing for your business, SoFi is here to support you. On SoFi’s marketplace, you can shop and compare financing options for your business in minutes.

SoFi's marketplace is owned and operated by SoFi Lending Corp.
Advertising Disclosures: The preliminary options presented on this site are from lenders and providers that pay SoFi compensation for marketing their products and services. This affects whether a product or service is presented on this site. SoFi does not include all products and services in the market. All rates, terms, and conditions vary by provider. See SoFi Lending Corp. licensing information below.

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.

External Websites: The information and analysis provided through hyperlinks to third-party websites, while believed to be accurate, cannot be guaranteed by SoFi. Links are provided for informational purposes and should not be viewed as an endorsement.

SOSMB-Q324-017

If you’ve always dreamed of opening your own business, now may be the time. The entrepreneurial spirit is thriving in the U.S. as historic numbers of Americans start their own companies. In 2023, a record 5.5 million new business applications were filed, according to the U.S. Census Bureau. The trend started in 2020 during the pandemic and has accelerated ever since.

There are many reasons why new business is big business today. For some individuals, the allure of running their own enterprise is a motivation too strong to resist. Others see opportunity created by changing consumer tastes and needs. For yet other people, starting a business may be a way to start over after a job layoff.

Small businesses are the backbone of the U.S. economy, employing 46% of the workforce, according to the Small Business Administration (SBA). But of course, a new business needs to stay in business. And one of the key factors that can help determine its success: Location, location, location.

So then, where is the best place to start a business? In what cities can a new business not only find its footing but go on to flourish?

To discover the answer, SoFi looked at the 50 largest cities across the U.S. with populations of 500,000 or less, and ranked them on eight different criteria, including annual business applications, average cost of office space, unemployment rates, and cost of living. We assessed the criteria for each city on a 10-point scale for a possible total score of 80 points. (See below for the complete details about our methodology.)

What we found was that while businesses are starting nationwide, certain cities across the country seem to be particularly beneficial for new businesses. Read on to learn the 10 best cities to start a business in the U.S.

Key Points

As SoFi analyzed the data about each city, these important findings stood out:

•   The South is a hotspot for new businesses. Three of the top 10 cities on our list are in Florida, and all score high in self employment. Plus, Florida has increasing numbers of businesses owned by underrepresented groups. Atlanta, the Number 3 city overall, has a large population of working age people and ranks high for new business applications.

•   Cold-weather cities are offering new businesses a warm welcome. Minneapolis clinched the Number 2 spot on our list, and St. Paul, Minnesota and Madison, Wisconsin scored in the top 10. All three have large populations of working age people.

•   Texas is poised to become a new-business powerhouse. The Lone Star State has 2 of the top 10 cities on the list — Plano and Irving. Younger people are gravitating to Texas, giving new businesses in these cities plenty of working age adults to employ.

Our Findings

Reviewing the entire list of cities in the SoFi analysis reveals some important, even surprising, information for aspiring business owners. For instance, Miami is the city with the most new business applications and highest level of self employment, while Witchita, Kansas, offers the best prices for office space, and Cleveland has the lowest cost of living.

Check out how other top cities rank when it comes to opening a new business.

The Top 10 Cities to Start Your Own Business

The best cities for new businesses tend to be in the South and Midwest, our research found. But no matter where they are located, each of the cities in our top 10 has attributes that make them great locations for aspiring business owners.

1. Miami, FL

Score: 52.13

This vibrant metropolis combines the perks of big-city life, such as an exciting food and nightlife scene and renowned museums and art galleries, with beautiful beaches and warm, sunny weather. Miami’s population has increased steadily in recent years, making it one of the fastest growing cities in the country. And tourists from around the world flock to this oceanside oasis. In short, there are endless opportunities — and customers — for new business owners in Miami.

In SoFi’s analysis, Miami received top scores for new business applications and the number of self-employed individuals. It also rated highly for walkability and its large working-age population. Not only that, prospective business owners in Miami may be able to take advantage of small business grants in Florida that can help with start-up costs.

Recommended: Small Business Loans in Florida

2. Minneapolis, MN

Score: 51.13

With its friendly midwestern vibe and cosmopolitan charm, Minneapolis has been experiencing population growth since the pandemic. Despite the cold winters, residents say it offers a good quality of life, access to nature, sporting events, arts and culture, and more. The city is also seeing a surge in new housing and economic development.

In the SoFi study, Minneapolis received a top score for its large working-age population. It also got high marks for the number of self-employed residents and the city’s walkability. Another potential selling point for entrepreneurs: The state of Minnesota works to cultivate small businesses, offering assistance and partnerships through its Office of Small Business and Innovation.

3. Atlanta, GA

Score: 50.30

Atlanta is another one of the fastest-growing metro areas in the country, according to Census Bureau data. The city has seen a boom in businesses opening and relocating there, from major corporations to smaller companies. Atlanta’s lifestyle amenities have flourished as well, making the city a draw for its vibrant entertainment offerings, diverse restaurants, and sporting events.

It’s no wonder then that Atlanta has a robust population of working-age individuals, according to SoFi’s research. It also got a high score in our analysis for new business applications. For entrepreneurs, the city has support networks, incentives, and small business loans that make it an appealing place to set up shop.

4. Plano, TX

Score: 48.89

New businesses are popping up across Plano, making it a welcoming community for those ready to launch their own companies. Located less than 20 miles from Dallas, the city is a family-friendly place to live with easy access to a major metro area. People are drawn to Plano’s parks, cultural events, and restaurant offerings — something new business owners can both enjoy personally and benefit from professionally.

SoFi’s research found that Plano has a large working-age population and a high household income. It also ranks near the top of the list for self-employment. Plus, small business grants in Texas can make Plano a good choice for new business owners.

Recommended: Small Business Loans in Texas

5. St. Louis, MO

Score: 48.48

Located on the Mississippi River and known for its iconic Arch, St. Louis is actively courting new businesses through incentive programs, tax credits, and enterprise zones. The city has a vibrant start-up scene, with business incubators and accelerators. St. Louis, which boasts a diverse culture, historic neighborhoods, and a fairly affordable cost of living, is a top area for job growth, according to recent data from the Federal Reserve Bank of St. Louis.

Indeed, SoFi’s report found that St. Louis gets high marks for its large working-age population, self-employment score, and household income.

6. St. Paul, MN

Score: 48.06

The state capital of Minnesota, and the other half of the famed “Twin Cities” (along with Minneapolis, the Number 2 city on our list), St. Paul is a mid-sized metropolis with a youthful vibe. There are a number of colleges and universities here, giving the city’s employers access to skilled graduates. In our research, the city ranked high for its large working-age population. In addition, St. Paul offers a number of resources for new businesses, including financial and technical assistance.

7. Orlando, FL

Score: 48.01

Home to Disney World and Universal Studios, among many other theme parks, Orlando is not only a coveted tourist destination but also a cosmopolitan city with a strong arts and cultural scene, good restaurants, and a bustling nightlife.

It also has a variety of employment opportunities to attract workers: Orlando is filled with big companies, such as AAA and Darden Restaurants, and it’s a growing technology hub. As a result, the city has a large working-age population, according to SoFi’s analysis. Orlando is welcoming to new businesses and offers many incentives to entrepreneurs.

8. St. Petersburg, FL

Score: 47.97

This Gulf Coast city is so beloved for its weather that it’s known as Sunshine City. St. Pete is appealing to employees and business owners alike for its working and lifestyle opportunities. Here, you’ll find pristine sand beaches and a walkable city with a dynamic business community. Companies like Raymond James and HSN are located in the city, as are a growing number of new businesses.

St. Petersburg has a booming working-age population and it scores high marks in self employment, the SoFi report found. It also offers tax benefits and incentives to new businesses.

9. Madison, WI

Score: 47.34

This state capital was recently rated the sixth best city in the U.S. to live in by U.S. News & World Report, thanks to its quality of life. Madison has a hot job market and it’s a hub for companies in technology, healthcare, and manufacturing. As a college town — the University of Wisconsin-Madison — it also has a diverse population and a dynamic downtown filled with boutiques, restaurants, bars, and coffee shops.

In SoFi’s report, the city rated highly for its working-age population. The unemployment rate in Madison is fairly low, which also makes it desirable. The city offers programs to help small businesses start and succeed, and there are small business grants in Wisconsin entrepreneurs can explore.

Recommended: Unemployment Rates by City

10. Irving, TX

Score: 46.97

Located near Dallas, Irving combines urban amenities with a suburban feel. It has many perks of city living, such as live music venues, ballet and symphony, art, movie theaters, and restaurants. For nature lovers, Irving has a number of rivers and lakes weaving through it, along with parks and nature trails.

Irving’s economy is strong — major corporations in industries such as technology, finance, and consumer goods are located there. SoFi’s research found that the city has a large working-age population, which can be beneficial to new business owners. Irving also offers incentives and resources for small businesses.

Tips for Small Business Owners

If you’re ready to start a small business, these are some important steps to take to help your venture become a success.

•   Choose the right location for your business.
Do your research to pick an area that best suits your business needs. Consider whether the area has the type of customer you’re targeting, a robust workforce, and real estate and operating costs you can afford.

•   Check out local resources, networks, and programs.
Does the location you’re considering offer incentives and tax credits for new and/or small businesses? The cities on our list do, as do many others. Be sure to check with the chamber of commerce, the city’s SBA office, if there is one, and local economic development centers and business incubators.

•   Find the right financing.
The city or state may offer grants or funding for new businesses — do your homework to find out if they do. Also investigate grants and funding programs from the SBA.

As you’re seeking financing for your small business, you may also want to consider a loan to help get your venture off the ground.

When you’re looking for a loan for your new business, SoFi can help. On SoFi’s marketplace, you can shop top providers to access the capital you need. Find a personalized small business loan option today within minutes.

If you’re seeking financing for your business, SoFi is here to support you. On SoFi’s marketplace, you can shop and compare financing options for your business in minutes.

Methodology

To determine the best cities to start a business, SoFi looked at the largest 50 cities across the U.S. with populations of 500,000 or less. (“Population” refers to the city proper and is separate from surrounding urban areas.) SoFi analyzed eight key contributing factors, each assessed on a 10-point scale, in each city for an overall potential score of 80. These factors included:

Walkability

Walkability was determined by reviewing statistics from Walk Score, which were given on a scale of zero to 100. The higher the Walk Score, the higher a city’s walkability score.

Cost of Living

Using Area Vibes, SoFi reviewed the cost of living score — an index score compared to the national average. The lower the cost of living score in a city, the better the score we assigned.

Average Cost of Office Space

Using LoopNet, SoFi assessed all 50 cities using the following filters:

•   Type of space needed: office, retail, or restaurant

•   Number of employees: 10 (which equaled 1250 to 4000 sq. ft. of space)

SoFi averaged the price per square foot per year for the newest 10 results in each city. The higher the average cost, the lower the score.

Median Household Income

Using Data USA, SoFi assessed the median household income for each city. The higher the median income, the higher the score.

Unemployment Rates

Using Area Vibes, SoFi assessed the unemployment rate for each city. The lower the unemployment rate, the better the score.

Annual Business Applications

Using Census Burea data SoFi calculated the percentage of people who applied for a small business loan in the county where each city is located. The higher the percentage of new business applications, the higher the score.

Percentage of Self-Employed People

Using Census Burea data, SoFi calculated the percentage of people in each city who had self-employment income. The higher the percentage, the higher the score.

Working-Age Population

Using Census Burea data, SoFi calculated the percentage of people in each city who were between the ages of 15 and 64. The higher the percentage, the higher the score.

SoFi's marketplace is owned and operated by SoFi Lending Corp.
Advertising Disclosures: The preliminary options presented on this site are from lenders and providers that pay SoFi compensation for marketing their products and services. This affects whether a product or service is presented on this site. SoFi does not include all products and services in the market. All rates, terms, and conditions vary by provider. See SoFi Lending Corp. licensing information below.

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.

External Websites: The information and analysis provided through hyperlinks to third-party websites, while believed to be accurate, cannot be guaranteed by SoFi. Links are provided for informational purposes and should not be viewed as an endorsement.

SOSMB-Q324-018

Invoice financing allows businesses to improve their cash flow while waiting for their customers to make outstanding payments. Like any type of financial product, invoice financing has advantages and disadvantages to consider before making a final decision.

We’ll walk you through how invoice financing works, what types of businesses it’s suited for, and alternatives to consider before deciding what type of business loan is best for you.

What Is Invoice Financing?

Invoice financing is a type of small business financing that leverages the outstanding invoices owed to you by your customers. Also known as accounts receivable financing or invoice lending, invoice financing is considered secured funding because your company’s financial invoices serve as collateral for the funds you receive.

In addition to this traditional secured loan structure, there are several other kinds of invoice financing. One of these is invoice factoring, another form of invoice lending in which you sell your unpaid invoices to a factoring company for a percentage of the invoices’ face value. The factoring company then becomes responsible for collecting from your customers, making it an attractive option for businesses that don’t want to chase down unpaid invoices.

Another form of invoice financing is an accounts receivable line of credit. With this type of business loan, you take out a line of credit using a percentage of the value of your unpaid invoices as collateral.

While it’s not suitable for all types of businesses, invoice financing can help many companies with longer billing cycles.

How Does Invoice Financing Work?

Invoice financing is a fairly straightforward process with four key steps. Here’s how it works:

1.   Submit an invoice: The process begins when you submit outstanding invoices to an invoice financing company. These invoices represent the money owed by your clients. At this point, the financing company will assess the validity of your invoices and the creditworthiness of your clients.

2.   Receive funding: Once the invoices are approved, the financing company provides an advance on the invoice amount, typically around 70% to 90% of the total amount. This advance is quickly transferred to your account, providing immediate cash flow to fulfill various business needs.

3.   Assess fees: In exchange for the advance, the financing company charges a fee, which can be a percentage of the invoice amount or a flat fee. This fee covers the service and the risk taken by the financing company. The exact fee structure varies based on the lender and the creditworthiness of the invoiced clients.

4.   Repay the lender: When the client pays the invoice, you direct the payment to the lender. The lender then deducts the advance and the agreed-upon fees before sending the remaining balance to you. This completes the transaction, and the cycle can begin again with new invoices.

Invoice Financing Example

Invoice financing can be tricky because it often uses a factor rate rather than an interest rate to calculate how much you owe. A factor rate may have a short term — such as a week — which means that your obligations will build quickly even if the percentage you see is low. Let’s take a closer look at how it works.

•  Submit an invoice: Let’s say you have a small business with an outstanding invoice for $20,000. You submit it to an invoice financing company.

•  Receive funding: The financing company accepts your invoice and they agree to advance 80% of the invoice value, or $16,000.

•  Assess fees: The financing company charges a 1% factor fee per week until your customer pays the invoice. If it takes four weeks for the customer to pay, the factoring fee would be $640.

•  Repay the lender: You repay the loan amount plus the factoring fee — a total of $16,640.

Invoice Financing vs Invoice Factoring

Invoice financing and invoice factoring are terms that are easy to confuse. While you might even see them used interchangeably, they aren’t the same.

Invoice factoring is a kind of invoice financing, but it’s not a loan. Instead, invoice factoring is a type of cash advance based on your outstanding invoices. You typically give the invoices to a factoring company and receive an advance of up to 90% of the invoices’ amount. Once the customer pays the invoice to the factoring company, you’ll receive the remaining balance minus a factoring fee that is withheld by the factoring company. Instead of being charged an interest rate, you’re charged a factor rate that’s based on the risk of your invoices.

Invoice factoring usually shifts the collection process to the lender. With invoice financing, your business typically keeps control of customer relations and the collection of your invoice funds. If you opt for factoring, your customers will likely know that you’ve outsourced this part of your business. Some businesses may prefer keeping the collection process in-house to maintain customer relationships.

Both invoice financing and invoice factoring involve ongoing fees. Typically, the longer each invoice goes unpaid, the more you’ll pay in fees. An important note: These tiered rates add some uncertainty to how much you’ll owe, so be sure to have some flexibility in your business budget for these fees.

Pros and Cons of Invoice Financing

As with any business loan, invoice financing can help your business in several ways, but it also has disadvantages to consider. Here are some key pros and cons to help you decide if financing invoices is right for your business:

Pros of Invoice Financing

Here’s a look at some of the advantages of using invoice financing.

•  Improves cash flow

•  Provides businesses with a working capital boost during slow periods

•  Allows continuity for businesses with long billing cycles who don’t want to operate order to order

•  Easy application (usually a credit check and invoice documentation)

•  Fast access to funds, sometimes within a day of application

Cons of Invoice Financing

•  Can be expensive, with potentially high rates plus other fees

•  Deprives you of a portion of your revenue

•  Fees are in part based on whether your customers are making payments on time

•  Using a factoring agency may involve them interacting with your clients, potentially affecting your relationship

Is Invoice Financing a Good Idea?

Invoice financing is certainly helpful in some business cases. If your company has seasonal fluctuations, a lengthy billing cycle, or revenues that aren’t distributed throughout the year — and your clients reliably pay their invoices on time — invoice financing may be a good way to keep regular cash flow through the highs and lows.

If your customers are slow to pay, however, the fees you’re charged may increase, and if they default, you may end up having to cover their invoices. If your business has less reliable clients, using funding like this could end up being costly in the long run and may not be a good fit.

How to Apply for Invoice Financing

Invoice financing is a valuable tool for companies looking to improve their cash flow by borrowing against outstanding customer invoices. Understanding the steps involved can help you make the most of this financing option and avoid potential pitfalls.

1.   Determine whether your business is eligible: Invoice financing primarily benefits business-to-business (B2B) companies rather than business-to-consumer (B2C) companies. It’s not meant for businesses that rely on individual customers who buy products through a point-of-sale system. Instead, it’s designed to let companies borrow against outstanding invoices for customer orders.

2.   Research potential lenders: Some lenders allow you to finance 100% of the invoice amount, while others limit you to borrowing up to a certain percentage of your outstanding invoices, typically within the 70% to 90% range. A lender may charge a flat-rate fee or a percentage of the invoice total. Either way, the fee is deducted when the customer pays the invoice. Depending on the lender, you may also encounter other fees, such as a new account fee, a renewal fee, a minimum volume fee, and/or an early termination fee. It’s always a good idea to determine the full cost of financing before you sign a contract.

3.   Submit your application and supporting documentation: When you apply for invoice financing, a lender typically reviews your business credit and the documentation of your unpaid invoices. A lender may also look at your clients’ payment history to gauge how likely they are to pay the invoices. A personal guarantee isn’t usually required, but check the terms of your loan to be sure.

Alternatives to Invoice Financing

Invoice financing is one of many options available to support your business needs. Here are a few other small business loan options to consider before making a final decision.

•  Inventory financing: This type of financing is used to help businesses purchase new inventory in large quantities and can be useful before a busy season or when you experience sudden demand for your product.

You can apply for either a loan or line of credit with inventory financing. The amount you can borrow is based on the value of your business’s inventory, but typically, you can only qualify for between 20% and 65%. Lenders may also use liquidation value as a starting point, as some types of inventory can lose value over time.

Like invoice financing, inventory financing typically comes with higher costs than a regular business loan. You’ll also need to demonstrate a high inventory turnover rate to qualify for higher loan amounts.

•  Merchant cash advance: A merchant cash advance is better suited to businesses with B2C sales. You borrow a lump sum, and the lender automatically deducts a portion of your credit and debit card sales until the loan (plus accrued fees) is repaid.

As with invoice factoring, a factor rate is used with a merchant cash advance instead of an interest rate. Another similarity is that your number of sales, rather than your credit history, is the most important factor in qualifying for a merchant cash advance. Generally, approval also happens quickly, allowing you to get fast access to funding.

•  Long-term business loan: A long-term business loan can last anywhere from several years to 25 years. Rather than bridging cash flow gaps, this type of financing is usually used for larger investments, such as buying real estate, renovating a building, purchasing equipment, or acquiring another business.

Expect eligibility requirements to be stricter with a long-term business loan. Lenders may require you to have been in business for a minimum amount of time and have a strong business and personal credit history. Additionally, you may need to offer some collateral and meet a revenue threshold.

Recommended: 6 Step Guide to Getting a Small Business Loan

The Takeaway

Maintaining steady cash flow can be tricky for many small businesses. Whether you’re looking for a short- or long-term financing solution, finding the best type of loan for your business can take time and consideration. You’ll want to carefully weigh the pros, cons, and costs of each option to find a suitable option.

If you’re seeking financing for your business, SoFi is here to support you. On SoFi’s marketplace, you can shop and compare financing options for your business in minutes.

FAQ

Is invoice financing easy to obtain?

Yes, invoice financing is relatively easy to obtain, especially for businesses with creditworthy clients and strong accounts receivable.

How expensive is invoice financing?

Invoice financing can be expensive, with fees typically ranging from 1% to 5% of the invoice value per week. Actual costs will depend on the creditworthiness of your clients and the terms of the agreement.

Is invoice financing risky?

Invoice financing carries some risk, mostly related to the creditworthiness of your clients. If clients fail to pay their invoices, you might still be liable for the advance received.

Photo credit: iStock/pixdeluxe

SoFi's marketplace is owned and operated by SoFi Lending Corp.
Advertising Disclosures: The preliminary options presented on this site are from lenders and providers that pay SoFi compensation for marketing their products and services. This affects whether a product or service is presented on this site. SoFi does not include all products and services in the market. All rates, terms, and conditions vary by provider. See SoFi Lending Corp. licensing information below.

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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In the world of business, the right location can make all the difference. ​​When business owners need to purchase, refinance, or renovate commercial properties, a commercial real estate loan (CRE) can be an excellent option. The term “commercial” refers to property that is used for business, such as offices, retail storefronts, warehouses, apartment complexes, and more.

CRE loans are typically available through banks and independent lenders, but you can also get capital from private investors and other sources, including lenders that partner with the U.S. Small Business Administration (SBA).

Whether you’re looking for a small commercial real estate loan or more substantial funding, it’s important to understand each option and how they differ. That way, you choose a loan that aligns best with your business needs.

Why Use a Commercial Real Estate Loan?

A commercial real estate loan is a powerful tool for businesses looking to buy, develop, or renovate properties. Commercial real estate loans offer substantial capital at competitive rates and flexible repayment terms, helping you undertake large projects without draining your reserves. By using this type of small business financing, you can expand your business’s operations, increase revenue, and strengthen your market presence.

Commercial Real Estate Loans Pros and Cons

Commercial vs. Residential Real Estate Loans

There are some similarities between loans for commercial real estate and residential mortgages. But there are also key differences to be aware of before you commit to a loan for commercial property.

Commercial loans are used to purchase, develop, or renovate properties intended for business use, such as offices, retail centers, and industrial buildings. Compared to residential mortgages, CRE loans typically have shorter terms, higher interest rates, and larger down payment requirements. The approval process for commercial loans also tends to be more intensive, often requiring detailed business plans, financial statements, and proof of income from the property.

Residential loans are used to finance personal homes and usually come with longer terms, lower interest rates, and smaller down payments. Residential loans primarily focus on the borrower’s credit score and personal income.

How Do Commercial Real Estate Loans Work?

Loans for commercial real estate are among the many types of loans available to small businesses and are specifically meant to help business owners buy or renovate property. A commercial real estate loan is offered only to a business entity — an individual or group of individuals who form an organization to conduct a certain type of business and related activities. These entities can include:

•   S- and C-Corporations

•   Funds

•   Trusts

•   Limited partnership

•   Limited liability companies (LLCs)

Typically, the property itself acts as collateral for the loan (which may then be called a non-recourse loan). However, if a business doesn’t have strong credit, a commercial real estate lender may require the owners or principals in the business to guarantee the loan. This provides the lender with an extra layer of security if the business entity itself can’t repay the loan.

Eligibility Requirements

A few eligibility requirements that lenders typically look for are:

•  Credit score: Lenders often require a strong personal and business credit history to assess the borrower’s creditworthiness and ability to repay the loan. A higher credit score can lead to better terms and lower interest rates on CRE loans.

•  Business finances: Detailed financial statements, including profit and loss (P&L) reports, balance sheets, and cash flow statements, help lenders evaluate the business’s financial health and stability.

•  Collateral: Similar to a residential mortgage, a commercial mortgage is secured by the property itself. This reduces the lender’s risk and can influence the loan terms and interest rates offered.

•  Business plan: A comprehensive plan detailing how the property will be used to generate income is often required. This helps lenders understand the potential for success and the borrower’s vision for the property.

Recommended: What You Should Know About Short-Term Business Loans

Loan Amounts

Loan amounts can vary depending on a few key factors:

•  Type of commercial real estate loan

•  Type of lender

•  Credit rating

•  Loan-to-value (LTV) ratio

•  Down payment amount

•  If the property is owner-occupied

The LTV ratio is particularly important because it assesses the value of the loan against the value of the property. To calculate LTV, lenders generally divide the loan amount by the property’s appraisal value. The average LTV range for commercial real estate loans is between 65% and 80%.

Interest Rates and Fees

It’s common for commercial real estate loans to have higher interest rates than a home mortgage, but they typically remain lower than other business financing options.

Additional fees may include:

•  Origination fees

•  Application fees

•  Closing costs

•  Appraisal fees

•  Prepayment penalties, if applicable

Loan Terms

Commercial properties can be a significant investment, and financing terms vary widely, ranging from a year for a short-term loan to 25 years with an SBA loan.

A key factor in loan terms is amortization, which typically exceeds the loan’s length, leading to a large final payment, or balloon payment, at the end.

For example, a five-year loan with a 30-year amortization period requires smaller installment payments but ends with a substantial balloon payment. If you’re unable to make this payment, securing additional financing may be necessary.

Common Types of Commercial Real Estate Loans

The type of commercial real estate financing you might seek depends on your business needs and eligibility. The different types may have different rates, terms, conditions, and purposes, depending on the lender. Here’s a look at some of the most common types of commercial real estate loans.

Commercial Mortgage

Commercial real estate mortgages are used to invest in properties for business purposes, such as retail, warehouse, office space, or storage. These mortgages are offered by traditional banks, government-backed lenders, life insurance companies, and hard money lenders.

A commercial mortgage can be beneficial for businesses needing a dedicated space for operations or inventory storage, and it can also build equity for future use. Something to keep in mind: These loans often have longer terms and involve larger amounts, making them riskier for lenders. As a result, the approval process can be time-consuming.

SBA 7(a) Loans

SBA 7(a) loans, offered by private commercial lenders who partner with the SBA, provide small business owners with flexible funds (up to $5 million) for various purposes, including non-real estate needs.

Qualifying for an SBA 7(a) loan can be challenging, requiring good personal credit, solid business revenues, and at least two years in business. Down payments typically start around 10% but can be higher depending on the lender’s specific requirements.

SBA 504 Loans

SBA 504 loans provide long-term, fixed-rate financing for renovating commercial real estate or purchasing equipment to help smaller, less-established businesses grow. They’re partially funded by certified development companies (CDCs), which are community-based nonprofits that help economic growth.

Businesses might choose 504 loans for their lower interest rates, longer terms, and lower down payments (around 10%). But these loans are meant for specific purchases, and businesses may be required to show proof of how funding was used. They cannot be used for working capital, inventory, or debt consolidation.

Recommended: Starting a Small Business

Bridge Loans

Bridge business loans are short-term commercial real estate loans with repayment terms ranging from six months to three years. They are used when a business cannot obtain a long-term loan, needs to refinance, or is waiting for other long-term financing.

Commercial bridge loans are ideal for covering small renovation costs or filling financing gaps while waiting for approval from another loan. The application process is typically faster than traditional loans. Note that bridge loans can be more expensive, so borrowers must ensure they can manage the higher costs before committing.

Construction Loans

Construction loans are used for building new structures or renovating existing commercial properties. They can be short- or long-term and are typically offered by banks, credit unions, or private investors through hard money loans.

These loans give borrowers flexibility with repayment and terms, covering costs for materials, labor, and other construction-related expenses. Because they are higher risk, lenders often require a down payment ranging from 10% to 30%, depending on the overall loan amount.

Land Development Loans

Land loans are commercial real estate loans used to purchase undeveloped land for future development, construction, or sale.

Business owners might choose a land loan if they need funding specifically for raw land, including making infrastructure improvements or creating subdivisions. Lenders often have requirements related to zoning, surveying, and land-use restrictions, and borrowing costs for less developed land may be higher than for improved land.

Mini-Perm Loans

Mini-perm loans are short term (three to five years) loans to help pay off income-producing construction or commercial properties or acquire investment properties until longer-term financing is available.

These loans are ideal for higher-risk projects when traditional financing isn’t initially an option. Mini-perm loans help establish payment history, which may also help to secure long-term business loans in the future. Because it’s riskier to lend to less-established businesses, lenders may charge higher interest rates. These loans assume the property will be profitable by maturity, so if projects exceed budgets or timelines, repayment can become challenging.

Hard Money Loans

Hard money loans are short-term commercial real estate loans based on property value rather than the borrower’s credit rating. The property acts as collateral, making these loans quicker and easier to acquire, which can be helpful for those with lower credit ratings or urgent funding needs.

These loans are usually offered by private lenders and have higher down payments and interest rates than traditional loans, with APRs typically ranging from 10% to 18%. Designed as short-term solutions, the high interest rates act as an incentive to pay back the loans as quickly as possible.

How to Apply for a Commercial Real Estate Loan

Applying for a commercial real estate loan requires careful preparation. You’ll want to look at various factors ranging from what the loan will be used for to how your eligibility will be assessed. Follow these steps to ensure you meet commercial property loan requirements:

1. Determine What the Loan Is for

You’ve decided to get a commercial loan, but what exactly is your commercial real estate loan best for? This is an important question since the answer may change the type of loan and lender you seek. Here are a few factors to consider:

•   Is the loan for renovations?

•   Are you planning to build a new structure?

•   If you’re making a purchase, what type of property are you purchasing: land for development, retail space, offices, storage?

•   Do you need to pay for labor and materials?

•   What is your budget?

•   Do you have other sources of funding?

2. Choose the Type of Commercial Real Estate Loan

After you determine what you’ll use the commercial loan for, you’ll be better prepared to research and choose a commercial real estate loan type. Some lenders offer specific types of commercial loans, which may limit how you can use the funds. A few examples of commercial loans are:

•   Construction loans

•   Commercial mortgage loans

•   Land development loans

•   Refinance loans

•   Hard money loans

•   SBA loans

3. Assess your qualifications

Each lender will have different eligibility requirements that may include:

•   Strong personal and business credit scores

•   A debt-service coverage ratio (DSCR) of 1 or higher

•   Down payment

•   A LTV of 65% to 80%

•   Healthy business revenue

•   Approved property type for the type of loan you’re applying for

4. Find a Lender

Use the information you’ve gathered about what you need the commercial loan for, what type of loan best aligns with your needs, and what commercial loan you may qualify for to search for lenders. Potential lenders can include banks, credit unions, and online lenders.

5. Prepare Your Loan Application

Commercial real estate loans typically require significant documentation to show lenders you’re a good candidate for the loan. While hard money loans may be faster to get and require less documentation, in general, it will help to have the following ready when you apply:

•   Up to five years of tax returns

•   Business financial records for up to five years or since your business was established

•   Credit reports for business and all owners/partners

•   Cash flow projections

•   Business plan (to show the property’s intended use)

•   Identifying information (which may include citizenship)

•   Third-party property appraisal

•   Historical income and expenses for the property

Depending on the lender and loan type, the application and approval process can take some time, so it’s important to be patient.

Alternatives to Commercial Real Estate Loans

If a commercial real estate loan doesn’t seem like it’s the right fit for your business, here are some other types of financing you may want to consider.

•  Restaurant loans: These loans help cover costs associated with starting or expanding a restaurant business.

•  Franchise financing: A franchising loan can help with costs involved with opening a franchise location. There are franchise companies that specialize in these types of loans.

•  Merchant cash advance (MCA): A merchant cash advance gives borrowers cash up front with an agreement that the lender will take repayment as a percentage of the borrower’s future credit card sales.

•  Invoice factoring: Invoice factoring gives borrowers cash up front in exchange for unpaid customer invoices. The factoring company (lender) is then responsible for collecting on unpaid invoices.

•  Business line of credit: A business line of credit is a common short-term loan option where borrowers receive a set credit limit and can borrow up to that maximum, paying interest only on the money withdrawn.

•  Personal business loans: In some cases, you may be able to use a personal loan to buy or renovate commercial real estate or make other business-related purchases.

The Takeaway

A commercial real estate loan can help finance the acquisition, development, and construction of a commercial property. This type of loan is available through several sources, including traditional banks, online lenders, and private investors, offering diverse options to meet your business needs.

If you’re seeking financing for your business, SoFi is here to support you. On SoFi’s marketplace, you can shop and compare financing options for your business in minutes.

Photo credit: iStock/ljubaphoto

SoFi's marketplace is owned and operated by SoFi Lending Corp.
Advertising Disclosures: The preliminary options presented on this site are from lenders and providers that pay SoFi compensation for marketing their products and services. This affects whether a product or service is presented on this site. SoFi does not include all products and services in the market. All rates, terms, and conditions vary by provider. See SoFi Lending Corp. licensing information below.

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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