What Is Business Financing?Unless your business has the balance sheet of Apple, eventually you will probably need access to capital through business financing. In fact, even many large-cap companies routinely seek capital infusions to meet short term goals For small businesses, finding the right funding model is vitally important. Take money from the wrong source and you may lose part of your company or find yourself locked into repayment terms that impair your growth for many years into the future.
- There are a number of ways to find financing for a small business.
- Debt financing is usually offered by a financial institution and is similar to taking out a mortgage or an automobile loan, requiring regular monthly payments until the debt is paid off.
- In equity financing, either a firm or an individual makes an investment in your business, meaning you don’t have to pay the money back, but the investor now owns a percentage of your business, perhaps even a controlling one.
- Mezzanine capital combines elements of debt and equity financing, with the lender usually having an option to convert unpaid debt into ownership in the company.
debt financing for your business is something you likely understand better than you think. Do you have a mortgage or an automobile loan? Both of these are forms of debt financing. It works the same way for your business. Debt financing comes from a bank or some other lending institution. Although it is possible for private investors to offer it to you, this is not the norm.
Here is how it works. When you decide you need a loan you head to the bank and complete an application. If your business is in the earliest stages of development, the bank will check your personal credit.
For businesses that have a more complicated corporate structure or have been in existence for an extended period time, banks will check other sources. One of the most important is the dun and bread street file. D&B is the best-known company for compiling a credit security on businesses. Along with your business credit history, the bank will want to examine your books and likely complete other due diligence
Before applying, make sure all business records are complete and organized. If the bank approves your loan request, it will set up payment terms, including interest. If the process sounds a lot like the process you have gone through numerous times to receive a bank loan, you are right.
Advantages of Debt Financing
There are several advantages to financing your business through debt:
- The lending institution has no control over how you run your company, and it has no ownership.
- Once you pay back the loan, your relationship with the lender ends. That is especially important as your business becomes more valuable.
- The interest you pay on debt financing is tax deductible as a business expense.
- The monthly payment, as well as the breakdown of the payments, is a known expense that can be accurately included in your forecasting models.
However, debt financing for your business does come with some downsides:
- Adding a debt payment to your monthly expenses assumes that you will always have the capital inflow to meet all business expenses, including the debt payment. For small or early-stage companies that is often far from certain.
- Small business lending can be slowed substantially during recessions. In tougher times for the economy, it can be difficult to receive debt financing unless you are overwhelmingly qualified.