Financing Your Business: What You Need To Know

Posted on: September 10, 2019

Before you are able to successfully set up a business, you need to first set up a funding strategy, because you simply can't have the former without the latter. The fact is you must have enough capital to purchase everything you will likely need in order to provide goods or services to your prospective clients.

Raising capital to finance your business involves raising money for diverse expenses. Those expenses can range from the most basic, such as rent or a lease of the property, to buying furniture, office equipment, and supplies, advertising your new establishment, establishing a presence on the internet and hiring staff to get things running.

It's also not just about getting capital, because there is a loan out there for pretty much every need. What is important is how you get the capital, because the wrong funding source can have negative implications in the actual day-to-day running of your business.

Even businesses that are well established need more financing and capital from time to time to ensure the smooth running of the business. Unless you're already running a highly profitable operation, it's very likely that you will occasionally find yourself financially short, thus have a need to access ready capital. It is not news that even large companies often seek external financing to meet short term needs. But as a small business owner, you have to be very careful before you choose a funding model, as funding from the wrong source can ruin your business.

Fortunately, in the United States, there are many financing options for your small and medium sized business. While obtaining financing isn't difficult, there are a couple of considerations before you sign on the proverbial dotted line. This article will serve as a guide for business owners who are looking for the means to raise money, as well as provide some important tips that every business owner should keep in mind.

First, let's understand that there are two types of business financing, namely, debt and equity. Taking on debt is far more commonplace than raising capital via equity funding, but both have their place.

Debt:

Using debt as a financing tool, you will get funding from a bank, credit union or some other alternative lender. Financing can take the form of a a loan, or a line of credit, either of which will give you access to funds that would need to be repaid within a specific period of time. Generally, you will be expected to provide some sort of collateral to support your loan, which could be a lien on your property (if you own it), or on the assets of your company (equipment, inventory, etc.). If you should default on your loan, you are essentially giving the lender permission to liquidate your asset to repay the loan. Some loan options will not require collateral; however, an unsecured loan is typically for a smaller, perhaps insufficient, amount as the lender's risk is not very great.

Equity:

With equity funding, you are not staking your company's assets as collateral; instead, you are staking your company. You are agreeing to share “ownership” of your company in exchange for capital. In simple terms, equity funding involves selling a portion of your business. You won't be required to pay back debt but you will now have a new partner. You should be aware that equity financing is a more complex option, and you should explore that option with the assistance of your attorney or CPA.

Regardless of the business industry or type of product or services you are planning to offer, there's a high probability that you will eventually need financing. While there is no singular perfect solution, there are viable options which we elaborate on below.

1. Savings

Using your own hard-earned money is the best way to finance your business, but it is definitely not the easiest. Of course, it will all depend on how much money you were able to save. If you can use your own funds as seed money to start your business, go for it. So long as you remain debt free and are able to run your business smoothly without altering your cash flow, that's a win-win. On the downside, your business will be limited to the amount of money you have been able to save.

If your personal savings are insufficient to fund your business, however, you may need to source other funds. Besides a traditional savings account, you could possibly draw from a pension or retirement plan, or even in some instances, your insurance policy.

Having said that, be warned that this option is not without risk. It is not advisable for prospective business owners to rely solely on their retirement funds or insurance policy because, if the business fails, you will have lost more than just that – you may have put your future in jeopardy. Before considering these options, be sure to consult with your CPA, financial planner or tax attorney who can help you assess the risk.

2. Credit Card

If you don't have enough savings to start or finance your business, a credit card could be an effective option. By using a credit card, you can extend your cash flow and, in some cases (depending on the card used), earn a discount in so doing. Although a credit card cannot finance capital-intensive projects, it can serve as a solution to emergency expenses. The disadvantage of using a credit card is that the maximum amount you can borrow is limited (and generally tied to your credit score); this means you may not have the ability to borrow as much as you need.

Using your credit card, you'll have access to the cash advance functionality, but there is generally a limit to the amount of cash you can get as an advance. Moreover, the credit card companies often charge cash advance interest at a significantly higher rate than purchases. Nevertheless, a cash advance can come in handy, especially when you are faced with an emergency.

You might be wondering, given the potentially high interest rates of a credit card, why you should consider this option? Credit cards are useful to businesses because they can temporarily extend working capital and help with cash flow, help with payroll and paying suppliers. Try not to over-rely on a business credit card, and remember that how you use the credit card determines how much of a loan you'll be able to access later. Provided you maintain your credit card account properly (i.e. repaying on time and making more than just the minimum payments), you could eventually have access to a higher credit limit.

2. Friends and Family

Having supportive family and friends is a blessing to every business owner. You can fund your small or medium business by convincing your family and friend to invest in it. You can sell a part of your business to them by having them make an equity investment, or you can borrow money from them and repay it as you would a traditional loan.

Using family and friends to fund your business has its downside, too; the main drawback is that the possible failure of your business could sour your relationship. No matter how close you are with your family member or friend, money can cause problems so you'll have to be practical in handling your relationship if the business goes wrong.

Sourcing funds from family and friends can also cause confusion with the running of the business. Let's say you sell equity to a family member, he or she might feel entitled to voice their opinion, and try to become involved in a business they know little or nothing about. Of course, this could lead to a major conflict; do you stay true to what you know will work for your business or do you you give consideration to their input, regardless of its value? Certainly, this will change the dynamics of your relationship, and very possibly, not in a good way.

Still, family and friends can be a very good source of funding your business, if you are careful about how you go about it. Make sure you draft an agreement, with counsel from your lawyer, and have it signed by the friend or family member so that there is clarity as to what will occur. Also, ensure that your new investor is fully aware of the risks involved in the business before he or she signs on.

4. Business loans and lines of credit

The bank is an ancient and reliable means of securing funding. Banks provide loans for you to run your business. Here's how a bank loan works; you offer the bank collateral in exchange for an agreement to lend you money, and you repay that money, over time, at a rate of interest pre-determined by the bank. The bank can either provide you with a traditional loan, which has regular repayments which reduce the outstanding, or they can offer you a line of credit which can be used as and when needed and which is paid back regularly and which increases the availability.

Getting a loan or a business line of credit from a bank can be a tedious process because the bank's only concern is about being repaid. They know that they will get their money back from you one way or another. If the loan is properly maintained, repayment will be through regular loan payment installments. If the loan is not repaid as agreed, they will liquidate the asset you put up as collateral. Of course, both will have implications on your credit score, positive and negative, respectively.

Provided your business has a steady cash flow, most banks will gladly give you a loan. Getting a loan or line of credit is a suitable way of financing your business and solving a potential cash flow shortage. Of course, that is, provided you are willing to undergo the often stressful process – the paper work, the credit check, etc., – and if you have a valuable asset that you are willing to stake as collateral.

5. Factoring

Factoring has been around for decades and has proven to be a reliable means for generating much needed funds. In recent years, it has experienced a resurgence of popularity and is now, especially in some industries, in high demand.

Here's how factoring works; as a business owner, you sell goods or services to your customer and you issue an invoice which your customer is expected to pay. That invoice can be sold to a third party, typically for about 70% of its face value; the third party accepts the responsibility for the collection of the invoice. After your customer pays the invoice, you would receive the remaining 30%, minus the third party fees.

This medium of generating funds is an easy way to improve your cash flow. If your company enjoys a high gross margin but you need to sort out slow or stagnant cash flow (as the result of slow-paying clients), then factoring may be a good option. However, it should be noted that factoring can only work if the majority of your clients have a reliable source of income and are able to repay the invoices, as no third party will want to inherit a debt that they may not be able to recover.

7. Get a Micro-loan

Getting a loan from a bank, while generally not difficult, is also not a certainty. For various reasons, some business owners may find it difficult to get approval and access to a traditional bank loan. Fortunately, even if you are in a similar precarious position, all hope is not lost. A micro-loan may be a good alternative.

You can get a micro-loan from micro lenders for as little as $500 to as much as $40,000, and they are designed specifically for small businesses. Although you will get a smaller loan compared to what you might be able to get from a traditional bank, the process is more streamlined and often times, the requirements far less rigid. On the downside, a loan from a micro lender may have interest rates that are considerably higher than a bank's, so you will have to weigh the variables. Across the United States, there are hundreds of micro lenders to choose from, once you've done your due diligence,

8. Consider Crowdfunding

Crowdfunding is one of the newer methods of funding your business. While, it's not as reliable as the other options, it may still be worth the effort. With the help of fundraising sites, you'll be able to raise money to boost your business; it is easy and fun and generally risk-free. All you have to do is sign up with a fundraising site and set a fundraising goal.

Let's say you set a target of $2,500 over one month, your family, friends and even strangers will be able to support your projects. Many writers, artists, and movie producers have benefited from this option. But you should be aware that not all crowdfunding websites are the same; some will require you to meet your goal before they will release your funds. As in all things, do your homework here so that your effort is not wasted.

You should also know that this option is not suitable for long term projects but it is appropriate for one time projects. If you want to facilitate contributions, you could offer an incentive to prospective donors; for instance, you can offer an album to donors that fund your album production.

9. Angel Investors

You can source funds from veteran investors, aka angel investors,who are more than willing to help struggling but potentially profitable businesses. These experienced investors will support you, not just with cash, but also advice and help with networking or connections to other funding mediums.

You should know that finding and getting an angel entrepreneur who is willing to invest in your business requires a great business plan, vibrant prospects, and dedication. When presenting your business plan to the investors, try to attain near perfection because you'll have only one chance to make an impression and you need to make sure that your first impression is a good one.

Conclusion

There are millions of small and medium scale businesses all around the world, and every year, more and more entrepreneurs join the party. For the majority of those businesses, they may someday face a singular challenge; how to fund their business.

Getting funds for your business does not necessarily have to be difficult. There are many options out there, so picking the best for your business is very important. Each option has its own set of challenges. For example, if your business is financed by a bank loan and you default, you'll lose the asset you put up as collateral. With a credit card, or through crowdfunding or factoring, you may not generate enough funds for some larger capital projects.

It's important that you first understand which loan option can finance and meet your need before you move ahead in the process of getting a loan. Your business is your “baby,” and most parents will do anything to ensure that their “baby” thrives; similarly, you will need to explore many avenues to ensure your business grows and succeeds.

If you have any thoughts or comments about what you've just read, please include them in the section provided below.

BizIt