Any business, no matter how good it is, can fall into a lull in which financially they need help being pulled up from. Without proper funding, a business cannot afford the equipment, marketing, and operations or to make payroll. Financing a business can become overwhelming for many business owners and navigating the way to come up on the other side can be confusing. There are companies, banks, and loan offices that offer support in this kind of situation, but before you go to one it’s best to know the different types and what they are all about. Doing so will help you better in terms of choosing the right kind for your business.
The Two Types of Business Financing
There are two major types of business finance to choose from. These are debt finance and equity finance. Generally speaking, debt financing are funds you borrow from a lender and is later repaid with interest. Equity financing, on the other hand, is a capital exchange for shares in the company or part ownership. So which ones are the best pick? Here’s what you need to know:
As mentioned, debt financing is a business financing option that does not give away part ownership but the money borrowed must be paid back with interest. This means that the loans can be made on the short term either 30 days to a year. These are often available from companies that are more established while the long term financing usually lasts from 1 year to 5 years especially it the money borrowed is a larger sum. This borrowed money could either be for starting a business or buying a piece of equipment as well as fixed assets.
A credit check is often needed for this kind of financing. In some cases, financing companies will see if you are worthy of lending the money to. In the check-up they will look at various factors:
- Credit rating or score
- Business track records and financial records
- Past banking history
- Your ability to repay the amount you have loaned
Your debt financing can either be secured or unsecured. A secured loan is something that has a fixed asset attached to it like a piece of property. In case you cannot meet the payments or make the payments, it is possible that the lender will seize that asset attached to your loan. Unsecured loans, on the other hand, are smaller but it does have higher interest rates compared to secured loans.
Advantages of Debt Financing
- You get to keep your business and at the same time make all the decisions.
- You have a choice of getting a long term or short term loan.
- The interest you pay is generally tax-deductible.
- The funds you need are readily available in case you need it.
- You must start paying right away.
- All borrowed money must be repaid in full plus interest rates at a given period.
- There is always a collateral attached.
- Repaying every month is a must and can be a source of draining your profits.
Where to Find Debt Financing
There is a wide range of places where you can find funding for your business. Choosing the right one will depend on how you establish your business. Your assets will also help determine what kind of funding is needed. So where can you find debt financing?
- Financial institutions like your traditional lender or bank. A credit union can also help you with this.
- Financing companies like online lenders as well as non-bank financial institutions.
- Retails can also provide debt financing through credit.
- Suppliers can provide you with trade credits on the services and materials you need for your business.
- Receivable finance or what they call as invoice financing is the use of unpaid invoices as an asset to help secure a loan or credit line is also a form of debt financing.
- Peer to peer loans is debt financing wherein you look for a loan with people looking to invest.
- Asset finance is a source of debt financing where you are able to secure a loan against assets on a company’s balance sheet.
- Family and friends can also initiate a debt financing for you but it is best to have it in writing so both parties can agree on the terms and conditions of the said loan. This way you can avoid conflict with any family or friend that you owed money with.
The second option you can take is equity financing where venture capitalists and investors are usually interested in. It is a risky approach to take for investors but there is also a reward for taking such risk.
Equity financing is defined as money that buys ownership in the company. Usually, an angel investor or venture capitalist will offer you seed capital or a large amount of funding for your new business. But they will take an ownership stake or a managerial stake in this business along with exit strategies that are usually laid out in certain periods.
There are plenty of businesses that fail in repaying their debts. And this is an opportunity for many investors because these repayments are often seen as a return if the business can make money. So in case you decide to take on this kind of financing, you must be well-versed in decision making, voting rights, dilution, valuation, and exit methods. This way you don’t lose your business in the long run.
Advantages of Equity Financing
- You don’t have to pay the loan immediately.
- You have more cash on hand since you are not required to pay it back right away.
- The investors can provide you credibility as well as skills in your business
- You lose some ownership of your business since investors are like your co-owners.
- You are not the only one making the decisions but you have to include the investors as well.
- The day-to-day decisions are all laid out and planned.
- Might take time to find the right people to invest in your business.
- Lots of people can be involved so you don’t own it solo.
Where to Find Equity Financing
Like debt financing, you can also find equity financing in many ways. Here are a few of them:
- Venture Capitalist is the type of people or businesses who specialize in creating investments in companies which they see as something with potential.
- Private investors or angel investors are similar to venture capitalists but are usually in the form of a company or firm.
- Crowd-funding is one of the most recent ways for equity financing which gives the public early access to services or products in exchange for funds.
- The government can also provide equity financing but only in certain circumstances. They have the power to grant loans to smaller businesses.
- Initial public offering means you must float your company on the stock exchange where you sell the shares to the public.
- Your family and friends can also be your source of equity financing. You can ask for a loan in exchange for part ownership in your business.
So whether you take a debt financing or equity financing for your business, the results of your success will always depend on how hard you work for it. Make sure to study the options well so you know what’s best for you and the future of your business, good luck!