Financing Basics

Inadequate or ill-timed small business financing is the main reason small business owners' new ventures fail. Sufficient ready capital is essential for starting or expanding a business. Having a small business loan or increased cash through angel investors isn't enough to succeed. Being able to plan bank loan repayments and keep up with bookkeeping is needed, too.

This article helps explain debt and equity financing options. It also covers how a small business owner can navigate and manage business finances.

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Forecasting Your New Business Financial Needs

Before inquiring about financing, ask yourself if your type of business needs the money. Also, ask what additional repayment expenses come with it. Consider how much debt versus equity you have in your new business. High amounts of debt won't attract investors or lenders to trust you if you haven't invested in your own business or gotten others to invest with you.

Answer these questions to understand your debt-to-equity ratio fully and what would be ideal for your situation:

• What is your amount of capital?
• Do you have cash flow right now? Could you manage it better?
• How do you define your needs? Is this cash flow for expansion, or does it make you feel comfortable having it?
• Do you need the money immediately? Can it wait until next quarter? Waiting may help you get the best interest rate terms.
• What is your credit history? Will you qualify for a business credit card? Or do you need to turn to private investors and venture capitalists?
• What are the risks in your industry or specific business?
• Where are you in creating or managing your business? Are you at the beginning or in a transition? Transitional stages can be harder to finance.
• What are you using the capital for? Lenders will ask this.
• Do you have a business plan? Investors and lenders will want to see this even if you're expanding or at a startup.
• Is your business seasonal or cyclical? Seasonal financing needs are generally short-term. Some loans or financing are given to "cyclical industries," like vacation kayak rentals, when their industry is off-season.
• Do you have your financial information available? Balance sheets, tax returns, and bank account statements will need reviewing.
• What kind of managers do you have? Are they competent and successful? These are the people who manage the company and budgets investors loan to you.

Don't forget to consider your personal assets and personal finance needs when considering finances. If you're a sole proprietor, be careful with your request. Overextending yourself in business financing can affect your credit score or good credit if you cannot repay it.

Entrepreneurs should also strongly consider the state of their industry when making financial requests. Businesses or industries in an off-season or with slow growth will approach financing differently than a thriving business. For example, a restaurant would have addressed financing differently than a webcam company during COVID-19. One industry was thriving due to work-from-home conditions, while the other was suffering from a lack of customers.

Equity Financing and Venture Capital

Suppose your company has a high proportion of debt to equity. In that case, a small business owner may want to increase ownership capital (equity investment) for additional funds. That way, you won't be over-leveraged like you would be in debt financing.

Limited Equity Financing

Limited equity financing is best for smaller businesses. Non-professional investors include:

• Friends
• Relatives
• Employees
• Customers
• Industry colleagues

Crowdfunding is another option. This is where small amounts are raised by many people. You can see this on websites like Kickstarter.

Venture Capitalists

Venture capitalists are the most common source of professional equity funding. These are institutional risk-takers like private individuals or government subsidiaries. Typically, these capitalists focus on a specific type of business or industry. One of the most well-known capitalist investing industries is California's Silicon Valley.

Most venture capitalists want a relatively young company that has the ability to become a regional or national company. These companies can bring in a high return on investment rate for the capitalist quicker than a genuine start-up just starting. While venture capitalists pick a small number of investment projects, they invest a large amount of money in their chosen project.

Primary concerns include quality management, a competitive or innovative advantage, and industry growth. The investors will typically work behind the scenes, staying silent unless their investment performs poorly. At that point, a venture capitalist may intervene in strategy or ask for new management.

Equity Financing Issues

Losing complete decision-making capability in your company is a major reason to avoid equity financing. Losing a share of your profits is another consideration.

If you want a venture capitalist to work with you, find a referral source. This could be someone in the industry. You can use the Small Business Administration (SBA) too. The SBA has licenses available for minority investment companies and other small business investment companies. These companies request equity in exchange for financing your business.

Debt Financing

You should seek debt financing if your firm has a high equity ratio to debt.

There are many sources for debt financing:

• Banks
• Savings and loan institutions
• Commercial finance companies
• U.S. Small Business Administration (SBA loans)
• Family members, friends, and colleagues

Small business funding as a short-term lender offering has been a traditional function of banks. These offerings include:

• Demand loans
• Seasonal lines of credit
• Single-purpose loans for machinery and equipment

Long-term loans are not a primary offering banks consider to smaller businesses or startups. This is why the SBA intervened with its guaranteed lending program.

It's harder to qualify for debt financing with a poor credit score. Your personal credit history matters to lenders, even if you are a small business. High interest rates are also possible, making it difficult to pay down the loans quickly. This could put your business at a disadvantage.

Contact a Small Business Lawyer

Talk to a business lawyer and accountant before choosing a lender, signing up for a credit card, or starting a crowdfund. Pick the best business financing for your long-term and short-term business goals and income statements.