How to Finance a Business
How to finance a business is one of the main concerns that every new business person has to resolve. There are two main ways of financing a business, equity financing and debt financing.
The majority of start-up or small businesses use limited equity financing. As with debt financing, additional equity often comes from non-professional investors such as friends, relatives or colleagues.
However, the most common source of professional equity funding comes from venture capitalists. These are institutional risk takers and may be groups of wealthy individuals or major financial institutions. Most specialise in one or a few closely related industries.
Venture capitalists are often seen as deep-pocketed financial benefactors looking for start-ups in which to invest their money, but they most often prefer three-to-five-year old companies with the potential to become major regional or national concerns which will return higher-than-average profits. Venture capitalists may scrutinise thousands of potential investments each year but only invest in a few.
Different venture capitalists have different approaches to management of the business in which they invest. They generally prefer to influence a business passively, but will react when a business does not perform as expected and may insist on changes in management or strategy. Relinquishing some of the decision-making and some of the potential for profits are the main disadvantages of equity financing.
Banks are one of the most common sources of debt financing. There are many other sources for debt financing including: savings, loans and commercial finance companies. It is also possible to ask for funding from family members, friends or colleagues, especially when the capital requirement is small.
Traditionally, banks have been the major source of small business funding. Their principal role has been as a short-term lender offering demand loans, seasonal lines of credit, and single-purpose loans for machinery and equipment. Banks generally have been reluctant to offer long-term loans to small firms.
In addition to equity considerations, lenders commonly require the borrower’s personal guarantees in case of default. This ensures that the borrower has a sufficient personal interest at stake to give paramount attention to the business. For most borrowers this is a necessary evil.
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