Small businesses are an important contributor to the economy as a whole. Starting or expanding a small business takes planning, hard work and of course, money. There are various ways to finance your small business because each small business is unique and has their own specific finance needs. This article will discuss the many debt and equity financing options as well as the pros and cons of each method.
Debt Financing is money that you borrow to run your business. It requires that you repay the money in full, usually in instalments that are subject to interest or finance charges. The lender assesses a variety of factors like the validity of your business plan, management capabilities, and personal financing to evaluate your company’s chances of success.
Debt financing includes the following:
- Line of Credit: A line of credit provides a business with money to cover day-to-day expenses. As funds are used, the amount of available credit decreases until payments are made. There is a pre-establish limit and you pay interest only on the amount outstanding.
- Credit Cards: Credit cards are short-term loans that allow you to make relatively small purchases today and then pay for them later. As long as you pay off your credit card each month, you will not pay interest on the loan. Many financial institutions provide credit cards designed for small businesses that help you keep track of company spending.
- Business Term Loan: A business term loan provides medium to long-term financing to cover some or all of the cost of capital equipment, expansion or renovation of buildings. Term loans are usually secured by the asset being financed, and they come with different repayment schedules, interest rates, and terms depending on the loan.
- Supplier Credit: Many manufacturers and suppliers have developed credit programs that you can use to make purchases. They provide the goods and you pay for them with interest over a pre-determined period of time. Some suppliers will offer a variety of financing options or discounts for paying it off early.
- Leasing: Leasing is a long-term rental where you have the option to purchase at the end of the lease based on its outstanding balance. A lease requires little or no money down and is normally used to purchase cars, machinery or office equipment. By leasing instead of buying, your business can write off the monthly lease expenses.
Equity financing is accumulated from savings and investors. Outside investors receive a portion of your company’s equity in return for their investments. The easiest source of equity financing for new companies is relying on people who already know you. It is not easy for a start-up business to attract investors. No matter how sure you are that your business with succeed, others will not always share your confidence. Without a track record of steady earnings from the business, you have only your enthusiastic attitude and your business plan to persuade them to invest in your idea.
Equity financing includes the following:
- Personal Savings: Many entrepreneurs invest their own savings when they start a business. It makes sense as your own money is the most readily available. If you invest your own money in the business, other people will feel more confident about investing their money.
- Love Money: Many entrepreneurs rely on friends and relatives for at least a portion of their financing, either as a debt or in exchange for equity.
- Informal Investors: Informal investors are professionals looking to invest their money in promising businesses. They are looking to earn a higher return on their investment than they would through traditional methods. They can play an active role in the management of the business by offering professional advice.
- Government: The government offers financial programs to boost employment, training or technology. A government program may pay some or all of your costs of developing a new technology or training new employees.
No matter how you finance your business in the beginning, a long term plan for success is essential.Setup reasonable financing terms with your clients and create a system for regular follow-up. By staying on top of your receivables, you will reduce your need to rely on credit.