Choosing the Right Financing Strategy Is Easy—If You Know the Rules
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One of the biggest issues facing most small business startups is financing. Too little money will likely doom your dream, or at least make it difficult to fully serve your customers. The wrong approach may provide you with plenty of funds at the outset, but also obligate you in ways that will have huge consequences in the future.
The two major categories of financing are debt and equity. Debt financing means borrowing money that must be repaid over a period of time, usually with interest. These loans are often secured by some or all of the assets of the company. In addition, lenders commonly require the borrower’s personal guarantee in case of default. This ensures that the borrower has a sufficient personal interest at stake in the business.
Traditionally, banks have been the major source of small business funding. However, they are often reluctant to offer long-term loans to small firms. To help fill the gap, SBA 7(a) program encourages banks to issue long-term loans up to $1 million for small businesses that are unable to find financing on reasonable terms through conventional lending channels. (More details about the SBA guaranteed loan programs are available at www.sba.gov/financing).
The other category, equity financing (or equity capital), is money raised by a company in exchange for a share of ownership in the business. Equity often comes from investors such as friends, relatives, employees, customers, or industry colleagues. The most common source of equity funding comes from venture capitalists—institutional risk-takers comprised of wealthy individuals, government-assisted sources, or major financial institutions. Most specialize in one or a few closely related industries. (For more on the different types of funding and what stage your business is ready to pursue, visit Funding Stage Definitions.)
While equity financing usually eliminates the need to repay specific amounts at specific times, investors usually have an expectation of receiving some kind of return on their investment. They may also insist on having some input on decision-making, and be less flexible about repayment should the business falter.
Other Funding Options
Other funding or cost-sharing options include partnerships, joint ventures, alliances, co-branding arrangements and business incubators. Incubators rarely offer cash, but they provide crucial support in the form of free or reduced rent and business services.
More details about financing for both startups and existing small businesses may be found at the SBA’s website, www.sba.gov/content/borrowing-money.
To learn more about financing a small business, contact SCORE “Mentors to America’s Small Business.” SCORE is a nonprofit organization of more than 12,000 volunteers who provide free, confidential business mentoring and training workshops to small business owners.
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