The Basics of Financing a Business
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All businesses need capital to thrive in a competitive landscape. Even the most successful businesses seek financing to meet short-term goals. However, finding the right business financing solution is essential because mistakes could end up costing you and your business. Luckily, there are many ways to finance a business and many loans to choose from. So whether you need to borrow money for operating expenses or to pay for inventory, there’s an option out there to help your business grow. This article will discuss the basics of financing a business and what your options might be.
Debt financing is a popular form of business financing because it works the same way as an auto loan or mortgage. When your business needs a loan, you’ll fill out an application, and the bank will perform a credit check. Depending on the developmental stage of your business, they can either check your business or personal credit. Lenders will also examine your books and check your records to ensure that you can repay the loan.
Before applying for a loan, organize your business records to make the process easier. Once the loan approves your loan, they’ll tell you about the payment terms, including the cost of interest. Debt financing has many advantages, including that the lending institution can’t control how you run your company and once your loan is paid back, your relationship with the lender ends. Additionally, the interest you pay is tax-deductible, making it an attractive choice for businesses that want to save money on their taxes.
Unfortunately, there are many disadvantages of debt financing, including the fact that you’ll add debt to your monthly expenses, which means having less to spend on the business overall. Additionally, lending financing can be more difficult for businesses to qualify for during recessions.
Equity financing means that your capital comes from investors, also called angel investors or venture capitalists. Investors give your business money in exchange for equity or ownership in the business. Depending on your deal, they may also require you to pay them back with a certain amount of pre-disclosed interest. Venture capitalists are typically firms rather than single investors. These firms deal in significant investments, so the process can be slow and complex due to the number of lawyers, accountants, and advisors who have to sift through all the details.
On the flip side, angel investors are simply wealthy individuals who want to invest in businesses. They typically invest small amounts into a single business rather than building multiple businesses at once. Angel investors move faster than investment firms, making them a better choice for startups and small businesses.
There are no lenders with equity financing, and if your business goes bankrupt, you won’t owe the investor anything; instead, they’ll simply lose their investment. Additionally, the business doesn’t have to make monthly payments, allowing them to free up capital and invest it back into the business rather than paying a lender. Unfortunately, the most significant downside of working with an investor is that you’ll have a new business partner because you’ll give up ownership of a portion of your company to someone in exchange for a loan.
Family and Friends
If you make a product that impresses your family and friends, they might be willing to invest in your business. Family and friends offer better repayment terms in exchange for their money, making it less stressful to pay them back. You also have options for how you’ll pay your friends and family back. For example, you can pay them back just as you would a debt financing deal or offer them stock in your company.
Clients and Suppliers
If you’re already doing business, you can begin leveraging your relationships to improve your cash flow. Most supplies ask for payment before shipping goods, but you can ask them to change their payment terms on invoices. For example, instead of receiving payment within 30 days after sending invoices, you can ask that they give you 60 days to make payment in full. Getting net-60 days to pay an invoice may require your supplier to trust you. However, after a few months, it’s a simple request that they can agree to or not.
If you work with clients, they may require net-30 payments, which gives them 30 days to pay you in full. However, this can create cash flow problems for small businesses just getting started. Instead, you can offer discounts for clients who pay early, which many of them will take advantage of, allowing you to improve your cash flow and build better relationships.
AR Line of Credit
An accounts receivable (AR) line of credit allows you to use your existing accounts receivable towards your credit limit. These loans are similar to commercial lines of credit, but they have different underwriting requirements. Lines of credit have flexible limits and are easier to obtain than traditional bank loans.
Purchase Order Funding
Purchase order (PO) funding can help businesses that resell goods pay their suppliers. In this scenario, the financing company will pay your business suppliers directly, allowing you to fulfill orders. PO funding is a great solution for small businesses that need help covering supplier costs, but it only works for transactions with high margins.
Asset-based lending (ABL) business financing allows lenders to assess your business’ cash flow and use your company’s assets to determine if you qualify for a loan. ABL covers a broad range of assets, including AR, real estate, and intellectual property, all of which serve as collateral to help you get the necessary capital. ABL financing is ideal for businesses with substantial assets that need significant financing with more flexibility.
The Basics of Financing a Business
The type of financing you need depends on the current state of your business. Consider what you’ll do with the money when you get it to ensure you have an effective business plan. Of course, you should also have a plan for paying back your loan (if you get one) and ensuring your business can survive with additional monthly expenses. If you’re ever unsure how to get financing for your business, consider speaking to a financial advisor who can help you find the right options based on your needs.
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