So, you want to learn how to secure financing for your business? Great! There are many ways to approach this, each with its own positives and negatives. Overall, there are two main types of financing: debt financing and equity financing.
Debt financing, which may sound scary, works the same way as applying for a mortgage on your home or financing the purchase of a car. Typically, debt financing will come from a bank, credit union or some other professional lending institution. Once you estimate the capital needed to start a business, you take this amount to your potential lender and they begin a process known as underwriting. This is where the lender evaluates your ability to repay the debt you are borrowing. They determine this by analyzing many things, including your personal credit history, any historical financial statements you may have, as well as the category of the business you are trying to fund. If they believe you can successfully pay back the loan you are applying for, they will make you an offer. This offer will include all the terms the bank is willing to give you, including interest rate, payment schedule and any collateral necessary to secure the loan.
Advantages:
- The lender has no control over how you run your business, and it has no ownership.
- If you successfully pay down your debt, you’re more likely to qualify for better debt financing in the future.
- Interest paid on debt is tax deductible to your business.
- If you have a fixed monthly payment, you can easily forecast this into your budget.
Disadvantages:
- Anytime you take on debt, you’re making assumptions about your ability to make payments in the future. If something out of your control happens to your business, you could fall short on your payments.
- The lender will own any collateral tied to your debt if you fail to make payments.
Equity financing involves giving up partial ownership in your business for the capital you’re seeking. Angel investors or venture capitalists are the most common types of equity investors. These types of investments are most appropriate for companies that are trying to grow rapidly and need cash up front to make this happen. Equity investors undertake a similar process to debt underwriting called due diligence. Within due diligence, the investors will assess your ability to successfully run the business you are presenting to them. After all, they are partnering with you in this endeavor and stand to benefit or lose similarly to you based on the business’ performance.
Advantages:
- Because equity investors are partners in your business, not creditors, their money is lost when the business fails, meaning you owe them nothing.
- With no monthly repayment requirements, all money raised can be invested directly into the business.
- Investors are typically more patient with their capital, allowing time for the business to grow.
Disadvantages:
- By giving up ownership, you are giving up a portion of all future payouts from your business.
- You now have partners in your business, for better or worse. These partners will expect to be included on key decisions that drive business performance.
Ultimately, you must weigh your options when deciding how to finance your business. If you struggle with the idea of giving up some control in your business, debt financing may be preferable. However, if you don’t have sufficient collateral or your business needs a large capital infusion to grow, equity financing may be the better option.
WHAT’S NEXT?
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Nick Oliver/EAP
Guest Blogger
