Business Loans

What Are the Main Ways to Finance a Business?

Financing a business is never an easy process, however, it is far from impossible. In reality, finding the money needed for your company is more a matter of knowing where to look and how to plan the future of your business, rather than knowing the right people and having a perfect credit rating. When it comes to small companies and start-ups, establishing what is the right financing model for your needs is essential.

There are many situations in which entrepreneurs accepted financing from wrong sources and ended up being locked into disadvantageous terms and conditions. In more serious cases, it is perfectly possible to lose part of your company if you are not careful when choosing an appropriate financing source.

3 Types of Financing That You Can Access

It is important to keep in mind that there are 3 very different financing models that you can choose from when it comes to accessing financial resources for your company. These are:

  • Off-Balance Sheet Financing;
  • Debt Financing;
  • Equity Financing;

Each of these has different advantages and disadvantages that you have to take into consideration and review thoroughly. Let’s take a closer look at each of them:

Understanding Off-Balance Sheet Financing

Unlike the other types of financing above, Off-Balance Sheet Financing is not an actual loan. Instead, it offers entrepreneurs a way to take large purchases off a company’s financial records. The main utility of this method is that it helps business owners make their company seem less debt-ridden, increasing its appeal in front of potential investors.

While this practice is considered to be in a legal grey area due to the fact that it can unrealistically bolster a company’s image, it is a service offered by most accounting companies and using it does not break any laws.

What Are the Pros?

  • It is a great way to hide large purchases from potential investors;
  • It can, in some cases, decrease the visibility of a company’s debt;

What Are the Cons?

  • It is more a damage control method, rather than a financing source;

Understanding Debt Financing

Although the name of this form of financing makes it seem overly complicated, it is actually extremely easy to understand. Debt financing is a financing category that includes automobile loans and mortgages. It essentially describes loans obtained from banks or private lenders. As a side note, loans received from investors also fall under this category.

The process of accessing debt financing is quite simple. You, as the owner of your company, can go to the bank, fill out an application form and wait for it to be processed by the lender. If the company is still in its starting year, the bank will check your personal credit score, instead of that of the business. Once your application is approved, the bank will establish the terms and conditions of the loan, including the interest rate and the term.

What Are the Pros?

  • The lender does not gain control over how you run your company;
  • The interest that you have to pay is tax-deductible;
  • Having to return the money through monthly repayments makes it easy to manage the company’s income and expenses;

What Are the Cons?

  • The monthly repayments can easily eat into the profit of small companies;

Understanding Equity Financing

This is the type of financing that most will be used to when it comes to the business world. With equity financing, the money comes entirely from investors. However, these financial entities are divided into two categories: Venture Capitalists and Angel Investors.

The former is often a large firm, rather than an individual and offers considerable amounts of money (starting at £2,500,000). As for the latter, angel investors tend to be wealthy individuals who are looking to invest in products offered by other companies rather than start a business of their own. These investors usually want clear and simple terms and move faster than venture capitalists.

What Are the Pros?

  • You do not have to return the money;
  • Equity financing is a way to access large amounts of money;

What Are the Cons?

  • Equity financing implies giving up ownership over portions of the company in exchange for the funds;
  • The investors will have a say in the direction that your company moves in and must be consulted in all matters;

Final Words

Ideally, you should try to find informal sources of financing, such as family or friends. However, if this is not an option or if you need a larger amount of money, then either of the three methods presented above will be useful. Regardless of what type of financing you choose, keep in mind that each of them comes at a price. Some will cost you control over the company, while others will take away some of your profits.