In our last post we talked about debt and equity financing (or funding), and which you might want to consider. Now we’ll branch out into some more detail on the types of debt and equity financing, so you can be better informed for your business.
Debt Financing Used by Most Small Businesses
Financial Institutions:
This includes :
– Commercial banks
– Community banks – local banks that focus on the community at large and have a keen—and vested—interest in maintaining solid relationships with both individual and commercial customers
– Credit unions – support the vision of their members
If you need short term financing, funds for a specific expense like machinery or equipment, or a seasonal line of credit, then one of these financial institutions may prove to be the most cost-effective and likely solution.
Customer or Supplier Financing
Many small business owners also have found that their customers can be quite sympathetic to their need to maintain a good cash flow, and that Customer or Supplier Financing is a viable way to raise money. This type of financing provides discounts for up-front payments for part or even all of the products or services you supply, generating cash for operating your business. If you need an injection of cash, promoting discounts for early cash payments on your invoices could well provide a needed shot in the arm.
Factoring
Another way that some business owners deal with cash flow problems is to take advantage of Factoring or Accounts Receivable Financing. With this source of financing, you can turn uncollected invoices into immediate funding by assigning your accounts receivable to a factor or agent and agreeing to discounts that may be comparable to higher interest rates. Although the factor receives a percentage of the amount you are owed, you may be relieved of all risks involved with collecting payment. A factoring agreement can be a somewhat complicated process, so we’d strongly recommend you talk to us about this – and we can point you in the right direction if need be.
Working Capital Financing
This is in many ways similar to a line of credit. In this case, the line is tied to your company’s receivables or inventory dollar amounts. With working capital financing, your lender might provide a 70 to 80 percent advance on your qualified receivables, or may advance up to 50 percent of the value of your inventory, allowing you to generate additional revenue or jump on a growth opportunity. Many federal, state, and local governments offer small business funding through Economic Development Programs. Typically, the funding is administered through banks, business development districts, and the Small Business Administration. When you’re investigating Economic Development Programs, don’t overlook that this type of funding often gives special consideration to specific ethnic groups, women, veterans, and companies located in designated urban and rural locations. You should also be aware that economic development programs usually require lots of documentation and paperwork, and may also stipulate that you pledge tangible assets, like real estate or equipment, as collateral.
Friends and Family Funding
Finally, some business owners raise funds through what is known as Friends and Family financing. Each of these deals is as varied as the relationship that underlies it. Just remember—no matter what the relationship—be sure to treat your deal as a full-blown business contract, and not a casual handshake. Put the amount of the loan and the terms of repayment in writing so that there can be no misunderstanding or confusion for any of the parties involved.
Types of Equity Financing
Selling stock or an ownership interest in a business is probably the best known and most common type of equity financing. It generally requires compliance with federal and state securities laws, calls for the assistance of financial and legal professionals, and is usually quite an expensive process.
One common route to selling stock in a company is through an Initial Public Offering (IPO). A Private Placement is a similar but less complex source of funding, since the equity investors who purchase the stock have been pre-selected. In both cases, stockholders may exercise control over your business in direct proportion to the number of shares they own.
In another source of equity funding, Private Investors called venture capital investors or “Angels” take an equity stake in your company. While this type of arrangement may include loans you won’t have to repay, it’s certainly not a free ride. You’ll usually have to give up a significant portion of your equity, and investors usually insist on providing business direction as well as financing.
It seems obvious that talking to an accountant is a critical step in financing – but we’ll say it anyway. We can help make the whole process much more effective, and can help evaluate all the options available and navigate the maze of bureaucracy and paperwork.
As you consider both debt and equity financing, you can take a short online questionnaire about raising funding. Don’t worry if you don’t have all the answers – but it’s a great way to start thinking through the process. Raising Financing questionnaire