Choosing the Best Financing for a Business
Choosing the best financing option for a business usually means deciding between equity or debt financing.4 min read
Choosing the best financing option for a business usually means deciding between equity or debt financing. This decision will help you secure the right type of funds to run your business. However, before determining what type of financing you need, figure out whether you really need financing and what is necessary to keep your business growing.
Even if you have an existing successful business, nothing ever runs completely smoothly. Equipment ages and breaks down, employees can make a costly mistake, or you need to purchase something expensive that you hadn't budgeted for.
The term debt financing refers to borrowing money. These loans typically have strict repayment timeframes including interest, but the tradeoff is you are not surrendering any ownership of your business. While loans are the most common types of debt financing, there are also options like lines of credit and credit cards. If you opt for a credit card, get a business one as they often have better deals and higher limits.
Loans require some type of security, known as collateral. This means some of your own assets could be at risk. In the event you default, the lender can go after your collateral and other business assets as necessary. Depending on your business organization type, they may pursue your personal assets, so it's important to do a risk-benefit analysis.
Long-term loans mean your repayment is scheduled for a period of multiple years. There are not as many restrictions on how the money is to be used, provided your business meets the borrowing qualifications from the lender. For new businesses, a long-term loan can be harder to obtain. Long-term loans offer some benefits since they allow you to repay a large loan in smaller, more manageable payments. Interest rates are also lower with long-term loans.
Other Debt Financing
Other financing options to consider include a line of credit, which is similar to a credit card. You can borrow money against a set limit. One benefit to a line of credit is you only pay interest on the money you borrow rather than the entire amount. This can be a great option for business owners who are not completely sure how much money they need to borrow.
Invoice financing is where companies purchase your accounts receivable through a cash advance for usually 85% of the invoice. When the client pays, you'll receive most of the remaining amount, minus fees.
Another option, as opposed to debt financing, is equity financing. Many small businesses rely on equity financing wherein an investor, or investors, contribute capital in exchange for a percentage of ownership and profits. While you reduce your ownership, it can improve your creditworthiness.
If the idea of giving up a part of your business concerns you, consider crowdfunding through websites like IndieGoGo and Kickstarter. With these sites, you share your project vision, explain how you will use the funds, set a fund goal, and then use social media to attract donors who contribute to your campaign. It's common to offer different levels of perks in exchange for higher dollar donations.
Choosing between Debt and Equity Financing
To decide which type of financing is best for you, you must decide what your business has to offer and what you are willing to give up in exchange for financial assistance.
- Asset types: Businesses that are asset-intensive often opt for a loan since they have the ability to use equipment to secure the loan. Startups typically opt for outside investors since they don't have the necessary assets for loan collateral.
- Network of connections: Knowing a lot of people is key to hopefully finding an introduction to an influential investor. He or she may bring in other investors as well.
- Industry: Your industry type may play a role in which type of financing is best. Healthcare, tech, and financial companies typically do well with equity financing since they promise good returns for potential investors.
- Funding amount: Investors often deal in multi-million-dollar investments, so equity financing is attractive for businesses starting out. Well-established companies that just need a little extra capital prefer debt financing.
- Control: Opting for equity financing means you sell your ownership in the business in return for financial support. This means, as part owners, investors can have a say and control over day-to-day operations. If you don't want to answer to anyone else, opt for debt financing.
- Timing: How quickly do you need financing. If you need it fast, debt financing is a better option.
If you need help with choosing the best financing option for a business, you can post your legal need on UpCounsel's marketplace. UpCounsel only accepts the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.