Once you have crossed from the initial business idea phase and you need to set up shop, the next thing you face is financing. Yes, you can fund your business from your savings, if you have saved the money or business is not capital intensive.
But even then, sourcing funds from other investors can save you from using all your savings into the business and also give you more capital to run the business.
There are two major ways to source funds for a business:
- Equity financing
- Debt financing
Equity capital or equity financing is when you give up a portion of ownership in your business in exchange for financial investment. In this case, the investor does not get back their capital, but they get to share in the profits of the business. It will, however, dilute your ownership in the company.
When using equity financing, ensure that the investment is well determined and defined to avoid confusion and lawsuits later. You can do this by issuing member units if it is a limited liability business. If it is a corporation, preferred stocks are the best option if you do not want to give the investor voting rights. Common stocks, on the other hand, allows the investor to also having voting rights in the decisions you make regarding the business.
Some examples of raising equity financing include:
- Venture capital – these are companies or individuals who invest in private business with great growth potential, or individuals with business ideas for unique and protectable services and products. Most venture capital firms will invest in a business that is already up and running.
- Angel investors – also seed investors, are businesses or individual investors who provide investment capital for a startup. If you are just starting up, an angel investor is the best as they are always willing to support a promising business right from the start. In exchange, you give them ownership in the business through ownership equity or convertible debt.
- Friends and family – while your loved ones might believe in you and line up to chip in, it is best to have a defined agreement on what ownership they get in exchange. The formal agreement cushions you from any lawsuits whether the business grows into a multi-million one or it fails, and they need compensation.
Unlike equity financing, where you get investment funds in return for ownership rights, debt financing involves getting credit. The money you raise from debt financing is repayable within the stipulated period plus interest.
Debt financing can either be secured or unsecured. Secured debt is where you offer an asset as collateral that the creditor repossess if you are not able to meet your repayment obligations. Unsecured debt does not have any collateral, making it the safest option.
Some of the common sources of debt financing include:
- Friends and family – if you are not willing to give ownership to your loved ones for financing, you can get the fund through debt financing. The good thing about this option is that the interest might be lower than what you would get from outsiders. Other repayment terms might also be friendlier. It’s also important to have this agreement in a formal agreement to cover yourself and the business against future lawsuits.
- Banks – many banks have loan options for small business owners. If you can provide the financials for an existing business, a business plan, and collateral, you can get financing.
- Commercial lenders– these lenders offer higher interest than banks, and their repayment terms are often tougher. Still, you will need to show a business plan, financial, and collateral.
- Government grants – governments also provide financing for startups in various industries. Do research on what your government supports and everything that’s required to get such grants.
- Bonds – you can issue bonds, where you specify the repayment date and interest, unlike borrowing from banks and other commercial lenders who determine such terms.
In conclusion, financing your new business depends on whether you want to share ownership or you are willing to repay the invested funds plus interest. Debt financing is ideal if you do not want to dilute the ownership of the business, but it can lead to loss of business and personal assets that you use as collateral when borrowing the funds. Equity funds dilute your control over the company, and you also have to share future profits with other owners.