How to find the fuel to start and grow your company.
Everyone knows you need to spend money to make money. For new businesses, though, the tricky part is usually coming up with any money in the first place. Fortunately, there are options for acquiring the funds you need to grow your business. If you are starting with no personal or business assets, or if you are looking to expand and take your business to the next level, there is a plethora of financing options available.
Debt Financing
Debt financing means that you borrow money with the obligation to pay the money back over a period of time. A traditional bank loan is an example of debt financing. So are credit cards.
The interest on a business loan can be considered a deductible expense, which lowers the real cost of obtaining funds. However, debt also incurs the risk of default, which can result in the forfeiture of assets.
Be sure to check out government-backed Small Business Administration (SBA) loans, such as the 7(a) and CAPLine programs. To encourage banks to work with newer (and presumably riskier) businesses, the federal government agrees to pay a certain percentage of the loan amount if the borrower defaults. The interest rates can be slightly higher than normal loans, though.
Microloans—a loan that can range in size from a few hundred dollars to $50,000—are an increasingly popular option, and they’re becoming more widely available from traditional banks, nonprofit organizations, and community organizations.
Equity Financing
With equity financing, a portion of the ownership in the business is sold in return for funding. The main advantage is that there is no default risk, but ownership rights in the business are shared with another individual or entity, which can complicate decision-making.
The additional owners may require dividends as well. Dividends don’t enjoy tax advantages in the same fashion that debt interest does.
For younger businesses, the most common way of finding equity partners is to turn to friends and family. But there are other options.
Venture capitalists can be private firms—they’ll expect high ROI, 25 to 40 percent equity, but no operational involvement. Or they can be public, such as the Small Business Investment Companies and Minority Enterprise Small Business Investment Companies overseen by the SBA.
Angel investors are high net-worth individuals (or groups of high net-worth individuals) who buy equity in a firm. They usually take a lower equity stake, injecting anywhere from to $25,000 to $1 million, but they usually want operational input. They are often successful entrepreneurs themselves.
Short-Term Options for Working Capital
This is typically done by established businesses, as they have working cash flow and established vendors and customers. Funding for operations over durations less than a month can be had through concessions with suppliers and customers. These agreements can ease the immediate demand for cash to pay the bills but will in no way provide the necessary funding for capital investment necessary to grow a business.
Some creative strategies using this method of financing included supplier credit (vendor willing to extend credit terms, such as net 30), customer credit (offer customers a discount if they prepay), and leasing (rental agreement that gives the use of an asset without having to buy it).
Other practices falling in this category would include having a finance company extend credit based on a customer contract, accounts receivable factoring (selling receivables to a finance company called a “factor” for a percentage of total value of the accounts), and creating a line of credit (borrowing against accounts receivable).
Self-Directed Banking
This method of financing, also known as Infinite Banking or self-directed banking, requires capital up front, so it’s usually not an option for most startup companies with no working capital. If they have the money, though, it can be a great way for an entrepreneur to build personal wealth, which can also be used to start and grow a business.
This is accomplished by creating a personal banking/financing system using a dividend-paying, mutually funded, permanent life insurance policy as a vehicle. Available savings and cash flow are used to build a personal and usable “bank.” The use of financing and incurring debt to grow a business can be intimidating and possibly confusing. The key is to find a financing vehicle that fits your business. Educate yourself on the options, and seek out a professional to assist in the process—a second opinion is usually advantageous.
