Sufficient capital is essential for a successful business, as is having the understanding of how to manage it properly. Common mistakes business owners make in securing financing include: obtaining the wrong type of financing, incorrectly calculating the amount of money needed, or failing properly estimate the cost of borrowing money.
To avoid missteps, there are several key considerations recommended by the Small Business Administration every business owner should reflect upon before seeking financing, including:
- Need: Are existing funds sufficient? Is there a way to manage the existing funds more effectively, or is there truly a need for more capital?
- Nature of the Need: Whether or not the need for financing is a planned strategy, or an emergency situation will affect the type of financing you seek, and the terms available.
- Risks: What are the risks involved with this request for financing? This will no doubt be influenced by some of the other factors listed here, such as the nature of the need and development stage of your business.
- Purpose of the Financing: The lender will likely require that any funds be used for specified purposes.
- Business Stage: Is your business just getting off the ground, or are you expanding?
- Management Team: Who is managing the business, and do they have any experience?
- Business Plan: The lender will want to review your business plan, and ensure that any financing request is in step with your business plan.
- Your Business' Debt-to-Equity Ratio: The debt-to-equity ratio is the relation between the money the business has borrowed and the money the owners have invested in the business. Generally speaking, it will be easier to obtain financing when owners have invested more of their money into the business.
Types of Available Financing
There are two types of financing: equity and debt financing. Which type of financing will be most appropriate for your business will depend on a variety of factors.
1. Equity Financing
Equity financing is where funds are obtained from sources who are granted a share in the ownership of the business. Sources of equity financing can include non-professional investors such as friends or relatives, but the most common source of professional equity funding comes from venture capitalists, according to the SBA. However, venture investments generally focus on high potential growth industries such as software or biotechnology.
The Small Business Administration (SBA) licenses and regulates Small Business Investment Companies (SBICs), which offer equity financing.
However, as attorneys must comply with their ethical obligations regarding ownership of law firms by non-attorneys and sharing fees with non-attorneys, this may be of limited use to attorneys starting their own law firm.
2. Debt Financing
Debt financing is where businesses borrow funds that must be repaid over an agreed upon period of time, with interest. There are many sources for debt financing, says the SBA, including: banks, savings and loans, commercial finance companies, state and local government programs, the SBA, and for smaller amounts, friends and family.
The SBA also operates a small business loan program, where it sets the loan guidelines and the loans are then made by partner-lenders. The loans are actually guaranteed by the SBA, thus reducing the risk to the partner-lender.