When entrepreneurs are looking for funding options, they are usually not seeking advice such as “crowdfund” or “ask friends and family.” While legitimate funding methods, most companies need something more reliable and in greater amounts than these methods generally provide. At this point, a business seeks more serious financing options from banks, external firms, and even non-profits.
However, finding the right funding can be a challenge for your company, especially when considering the various pros and cons of each method. As such, it’s important to educate yourself on the types of business financing available to you, and ultimately, select the best financing for your needs.
Understanding Two Common Types of Funding
The first step in financing your business is determining what you are willing to compromise: ownership or financial freedom. For those that are in earlier stages of developing their business, or managing a company that is locally sustained, answering this question is going to be the guiding force between which type of financing options are available to you.
This is the type of financing with which many are most familiar. Debt financing includes many familiar channels of debt, including bank loans, borrowing from friends and family, and credit cards.
While this method offers quick coverage if your credit score is good, the method poses severe risks to your personal finances. If you are unable to make a payment, it’s your personal assets that are on the line. Secondarily, in the process of repaying your debt, you will be responsible for interest payments on your outstanding balance-raising your overall monthly cost.
Examples of Debt Financing
- SBA Loans
The unique feature about SBA loans is that they are backed by the federal government. In addition, there are 14 types of SBA loans, meaning those with trouble finding financing usually can find what they are looking for through at least one of these programs.
- Term loans
Term loans are among the most familiar, though not always the most useful, especially to newer businesses.
A term loan offers a fixed amount of funding that you acquire for a specific purpose. You then repay that loan over a fixed period of time at a fixed rate of interest. As you can imagine, these plans are rigid and not always a good option for businesses with fluctuating or seasonally impacted revenue.
- Invoice financing
This type of financing allows businesses to use their unpaid invoices as collateral for a loan. Most useful for businesses that run off credit or experience long waits between rendering service and payment, using invoices as collateral, is often a good way to improve company cash flow.
- Business Line of Credit
This type of financing is incredibly flexible if (and when) you are granted coverage. Essentially, it works similarly to a credit card, offering you a line of credit for using many experiences with few questions asked. Having an increased line of credit can thus help forward costs on expensive equipment or hold out during a time of decreased revenue.
On a personal scale, there are generally fewer opportunities for equity financing because the practice doesn’t apply. In equity financing, you will sell some percentage of your business to another individual or firm. In exchange for this percentage, you will receive funding.
Unfortunately, by selling a percentage of your business, you are also selling some of your decision-making powers. After all, if a firm is bankrolling your endeavor, they will want a say in how it grows.
Examples of Equity Financing
- Venture Capital
Venture capital funding is the star player in popular investment shows such as Shark Tank. As part of the financial exchange, the venture capitalist, whether a firm or individual, usually provides business guidance and networking to the business through their firm.
- Angel Investments
As the name suggests, these are benevolent investors who operate as individuals to give financing to early startups. Apart from operating as individuals in the earliest and riskiest stage of financing, angel investment works similarly to venture capital, with the investor asking for an interest in the business equity in return for their assistance.
A Balancing Act
The main differences between these types of financing is the long term impact on financial freedom and decision-making power within the business.
When you borrow money from a financial institution, you are responsible for the repayment of long-term loans. This can sometimes financially handicap your cash flow as the same monthly amount is always due regardless of your income. Should you ever be unable to make payments, your business and personal finances will be at risk.
In the case of equity financing, these problems largely go away. The result, however, is the risk this type of financing poses to your overall business plan. When selling equity in your company, you give decision-making power over to your lenders. The greater percentage they own, the more power they have. This makes it imperative that, if you do go the equity route, you are working with a lender that has similar goals and visions to your own.
A Third Option: Revenue Based Financing
The best financing options for a business often do not fall into either Equity of Debt Financing. Often, individuals do not have the resources available to foot a small business loan, nor can they find an equity firm willing to invest. This puts many smaller-scale entrepreneurs at an unfair disadvantage.
At this point, Revenue Based Financing becomes a reliable option, so long as a business owner can prove their company is profitable.
Revenue-based financing is completely different- a company gives you a loan in exchange for a portion of your business revenue. This portion is paid to a predetermined point, normally when 3–5 times the amount of the original loan is paid. However, unlike debt financing, there is no interest associated with these costs and there is no need for fixed payment. This is because the payments ultimately function off a royalty system and thus fluctuate in ratio with your profits.
Through this type of financing, individuals can benefit from the security and network of an equity firm without giving up ownership to part of their business. Without a set dollar amount owed per month, a buffer is created against the devastating financial loss of a slow month in a new company.
Together, this makes for a rare financial buffer. Companies are only responsible for a percentage of royalties paid out, meaning there will never be an unpleasant surprise if they experience a slow month. Similarly, they can start a business in the way they desire, as they retain full ownership.
For many, this offers more security and freedom than taking on debt or working with venture capitalists.
Entrepreneurs Funding Entrepreneurs
At RevTek, we take qualifying companies and help them reach their expansion goals by giving them the financial support where it’s most needed. With a full staff of experienced entrepreneurs, we can help businesses assess their strengths, weaknesses, and help them refine and achieve their goals.
To begin the conversation about how to take your business to the next level, click here ⇒ contact us.