Whether you have an enormous company or a small start-up business, things won’t always run smoothly. For example, your equipment can break down when you least expect it, or supplies can cost more than you budgeted, leaving you needing extra funds to cover operating expenses.
For most business owners, one of the most straightforward ways to secure additional funds is by taking out a business loan. However, there are many other ways you can obtain extra finances for the day-to-day running of your company.
If you are a small business owner, check out small business funding marketplaces like these to better understand your options.
Here’s a how-to manual for finding the business financing route that makes the most sense for you.
What are the main types of financing for a business?
Typically, debt financing and equity financing are two primary financing options for a company.
This type of business financing option simply means borrowing money and paying it back later with interest. The most common type of debt financing is taking loans. One of the advantages of this option is that your lender will not have any control over your company during and after you finish paying your loan.
Also, in most cases, the interest you pay on top of the money you borrowed is tax-deductible, therefore alleviating a little bit of financial burden on you.
However, the main downside of taking a loan for your business is that you have to provide collateral. It could be some of your business assets or even personal assets (if you have a limited liability company.) This collateral means that if you cannot pay back the loan, your lender will claim your property.
To an extent, a loan may also become a burden to your business, especially if you fail to realize the profitability you had projected.
Equity financing involves selling your business’ equity in return for extra capital to build your business. In simple terms, you will be giving up a certain percentage of your business’ ownership in exchange for money.
Among the benefits of this financing option is that you will not be obligated to pay back the money. Of course, you’ll still be required to share your company’s profits with your investors, but there won’t be any interest or scheduled payments as it is with debt financing.
The main disadvantage of this method is that once you sell a percentage of your company to an investor, they will automatically be involved in everything concerning the daily running of your business.
Because of this involvement, you will have to consult them on every decision you make, share your profits with them, and so on. Depending on your company, the partial loss of control may outweigh the benefits of financing.
Factors to consider when choosing a financing option for your business
Some financing options might be more suitable for your situation than others. Here are some things to think about before committing.
Your long-term goals
Where do you see your company in the next five or ten years? What do you need to do to make that vision a reality? Questions like these might help you determine the kind of financing you require. For example, if you are keen on entering a particular market, you might partner with a specific investor who can help you branch out into that customer base.
Control of your business
If you prefer selling your company’s equities to obtain capital, it’s essential to consider how much of your business’ ownership or control you’re willing to give up to stakeholders.
Usually, the more stake you give up, the more capital you are likely to raise. However, surrendering more than 50% of your stake means that investors will have the upper hand when making major decisions.
Some of the things lenders check before granting loans to businesses include:
- The business owner(s) financial background
- The business plan
- The business’ debt-to-equity ratio
Knowing these qualifications will help you prepare your business in advance to enable you to meet the lender’s borrowing requirements.
Loan interest rates
Some lenders might not be as strict as banks when giving out loans but instead charge high-interest rates. Taking such loans may end up doing your business more harm than good. For one, the total cost of the loan may eat deep into your profits. Secondly, you might default, leading to a poor credit rating.
Even when dealing with banks, it is advisable to compare interest rates across the board to find the best deal. If your business qualifies, your first port of call should be a specialty loan, such as a Small Business Administration (SBA) loan, as it has lower interest rates.
Your current business structure
Your company’s ownership structure will play a significant role in the type of financing you can access. For example, if you run a sole proprietorship business, you might find it harder to access a traditional bank loan. Banks generally prefer LLCs, C Corps, and S Corps because they are more credible.
Access to investors
If you want to obtain capital through equity financing, you first need access to investors interested in buying shares of your company. And to do so, you have to prepare your business to make it more appealing to potential investors.
Here, you might need to create a solid business plan, reduce operating costs, and create a novel product or have a reputable brand.
Loan’s future repayment terms
Before taking a business loan for your company, it’s also essential to think about the lender’s repayment terms. Some lenders have complicated terms that may inconvenience your business in the long run. For example, some may impose hefty penalties if payment is not made within a specific time frame. These could quickly add up and weigh you down if you cannot make timely payments.
Choosing a financing option for your business is not a decision that you should rush. As we have seen, it might have a significant impact on your business. In other words, it could build your business or overburden you and eventually choke your enterprise. Hopefully, this detailed guide will help you make a more informed decision.