Introduction To Types Of Small Business Finance

The SBA is where people usually go to when in need of small business finance, since the SBA has a nice collection of financial aid and grant offers. In case none of these options is available, that still leaves a huge number of purely commercial financing choices. Listed below are all these possibilities and their relative merits and demerits.

The most basic question that the business owner needs to ponder over is whether to opt for debt financing or equity financing. Each has its pros and cons and further sub-divisions in terms of types of financing. Which one is more suitable depends on factors such as the type of business, its age, cash flow and the credit rating and history of the owner.

Debt finance is a bond, loan or a line of credit from a lender. It could also be as something as simple as an IOU. This works best when there’s a specific project involved and clear timelines are provided, so that the lender and borrower can agree on a repayment schedule. Some kind of security or collateral is often mandatory.

The owner’s credit rating and history will have a big impact on the ability to secure small business financing. The business also has to have a good enough cash flow (or projected cash flow) in order to meet the repayment schedule. It is important for the owner to do some business planning to figure out a feasible repayment period based on cash flow.

On the other hand, equity investors pump in funding in return for partial ownership. The owner is no longer the sole decision maker, which means it is important to choose the right kind of equity investors. The advantage is that unlike small business loans, there is no interest and no repayments to worry about so it helps the business grow faster.

The equity option is feasible for broad and long-term financing needs which have no specific and immediate timelines for an ROI. To be noted that equity investors seek higher returns, even if it is after a relatively longer delay. The owner is not likely to regain full control in the short-term and probably not even in the long term.

Venture funding is one example of equity financing. It could also be angel investors or individual investments made by colleagues, staff, friends or family members. The focus is on whether or not the business has a successful business model and possibilities for growth. Collateral or any other kind of security is not needed.

These basics should be enough to help a business owner make the fundamental choice of equity vs debt. To be noted that there needs to be a balance. Excess debt can hurt the business, and so will too much loss of control to an equity investor. The right balance is a combination of the two and the exact ratio of debt to equity changes based on the industry and business type.

Lastly, there are more factors to consider such as how the funding is best utilized. If a business needs finance for new equipment, then there’s a choice between buying it outright with a loan and opting for equipment leasing finance. The latter keeps the company clear of debt with the possibility of a purchase in the future. To make sure the owner is aware of all such small business finance choices when conducting their business planning, it might be advisable to consult someone at the bank, read a small business blog or a lawyer.

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