Introduction To Types Of Small Business Finance
The best to place to start looking for small business finance is with the SBA. They have all kinds of financial assistance and grant programs for small business owners. Assuming there’s a need for financing from the commercial market outside of the SBA’s purview, outlined herein are a few basics about the options available to small business owners.
The most basic question that the business owner needs to ponder over is whether to opt for debt financing or equity financing. Each has its pros and cons and further sub-divisions in terms of types of financing. Which one is more suitable depends on factors such as the type of business, its age, cash flow and the credit rating and history of the owner.
Debt finance can be a loan, bond or line of credit from a bank or other lenders, or even a simple IOU. It is usually the best option when the business project is very specific and has a well defined timeline. The borrower needs to put up something as collateral as a form of security.
The owner’s credit rating and history will have a big impact on the ability to secure small business financing. The business also has to have a good enough cash flow (or projected cash flow) in order to meet the repayment schedule. It is important for the owner to do some business planning to figure out a feasible repayment period based on cash flow.
With equity financing, the owner offers the investor part ownership in return for cash. It has certain disadvantages such as loss of control, since the investor would like to a part of the decision making process. But unlike small business loans, equity investments don’t need to be paid back with interest, so it makes it easier to run the business.
The equity option is feasible for broad and long-term financing needs which have no specific and immediate timelines for an ROI. To be noted that equity investors seek higher returns, even if it is after a relatively longer delay. The owner is not likely to regain full control in the short-term and probably not even in the long term.
Equity investment can in the form of individual investments made on a personal basis by the owner, friends, family, colleagues or angel investors. It could be funding provided by a venture capital firm. Equity financing is more focused on the success potential of the project and does not require the kind of guarantees or collateral required for debt financing.
As mentioned above, the decision on debt vs. Equity will depend on the type of business, its current situation and the owner’s credibility. Too much debt is not good for the business, and neither is losing control entirely to equity investors. The right balance needs to be found, and this debt-equity ratio is different for different kinds of industries.
On a related note, it helps to have more options on how to use it to maximize the impact of the financing on the business. For instance, instead of purchasing equipment outright, it might be beneficial to consider equipment leasing finance. There are many more such things that need to be considered, and it is best to consult a lawyer or trusted banker for more information regarding suitable options for small business finance.