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Financing for Small Business | A Complete Guide

Financing for Small Business | A Complete Guide

What are the best financing options to help fund your small business? Read our guide to learn everything you need to know about financing.

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Financing for Small Business | A Complete Guide

Navigating Financing Options: A Guide for Small Business Owners

Whether you’re just opening your small business or are established after several years, financing is a key consideration for your operations. After all, there may be times when you need to seek funding during volatile moments or when you are looking to expand. The big question: what financing option is the smartest move for your company? From crowdfunding to equity financing to grants, there are options out there – but you want to ensure your financing matches your business needs, goals, and capabilities.

Here, we’ll break down the most common financing choices and give you the best tips and tricks for selecting the right avenue for your business. 

Understanding the Different Types of Financing Options

Equity Financing

One of the most commonly sought-after financing options is equity financing. Here, your organization will issue shares to investors in exchange for capital. Since investors will then own a stake in your company, they benefit from its success. 

Pros of Equity Financing

  • Potential for Growth: Investors can be well-connected and seasoned in your field. As a result, you can benefit from their experience to help accelerate your company’s growth. 
  • No Repayment: Another huge advantage of equity financing is that the money you raise will not have to be repaid. Instead of worrying about making monthly payments, you can focus on your business operations. 

Cons of Equity Financing

  • Shared Profit: Since investors have a stake in your company, they will expect to receive some of your profit. Some business owners may view this as a loss of control over their success. 
  • Time-Consuming Process: Raising funds through investors can take more time as it involves finding investors and pitching your business. You may find yourself going through several rounds of investors before finding the right one. 

The Process

To start the equity financing process, you’ll first have to decide which type of investor is right for your company. These could include angel investors, venture capitalists, or even friends and family. From there, you must sort out the terms of the deal, complete the due diligence process and sign all legal paperwork. 

Ideal Situations for This Option 

Companies in the early stages of their operation often benefit the most from equity financing. After all, they may find it difficult to secure a bank loan due to their lack of financial history. 

However, companies that are well-established but want to grow at a faster rate could also benefit. Specifically, these could be companies that want to expand to a new market, develop new products, or seek an acquisition. 

Debt Financing

Debt financing is when you raise funds by borrowing money from an outside lender or bank to be repaid at a later time. Loans can vary from installment loans to revolving loans to cash flow loans. You can also choose between short-term loans, which typically go for 12 months, or long-term loans, which can go up to 10 years. There are plenty of options for each business’s circumstances, which can be useful but sometimes overwhelming if there is some doubt about which one is best. 

Pros of Debt Financing

  • Tax-Deductible Payments: The biggest benefit is that the interest payments on your debt are tax-deductible as long as you are borrowing from a lender and using it for business purposes. Reducing tax liability is always a useful strategy. 
  • Build Better Credit: You’ll also be able to build your credit by making payments on time. With better credit, you’ll be more likely to qualify for other business loans down the road. 

Cons of Debt Financing

  • Comes with Risks: Taking on debt is always risky, particularly if you have trouble making your payments. Doing so can lead to a hit in your credit rating and the risk of losing assets if you put them up as collateral. 
  • Qualifying Can be Difficult: The ability to qualify for debt financing will depend on your credit score, current financial standing and how long you’ve been in business. 

The Process for Debt Financing

Before seeking debt financing, you’ll have to ask the right questions. Is your organization in a safe place to take on debt? How much capital do you need? What are your qualifications for receiving a loan? Once you’ve settled on these terms, you can shop around for debt financing options. Some of the most common include banks, credit unions, consumer finance companies, and commercial finance companies.

Ideal Situations for Debt Financing

Debt financing is ideal for fast-growing businesses looking to secure funding at a lower cost than other traditional methods and at a faster rate. Alternatively, organizations that need short-term financing could also seek this out to help cover costs quickly. This option makes more sense than equity financing if there is a substantial interest in retaining as much ownership over the business as possible. 

Grants and Subsidies

Grants and subsidies are financial assistance awarded to businesses by either public or private bodies. Grants are funds given to organizations for a specific purpose and include requirements the organizations must meet. Subsidies, on the other hand, are usually given in the form of payments for tax contributions or tax breaks and can help businesses get on better financial footing. 

Pros of Grants and Subsidies

  • No Repayment: Like with equity financing, grants and subsidies do not have to be repaid. However, keep in mind that funds must be used for the exact purposes they were granted for.
  • Availability of Assistance: Fortunately, the federal government offers many resources for finding and applying for grants. These include grants from the Small Business Administration (SBA) and Grants.gov

Cons of Grants and Subsidies

  • High Competition: Many small businesses desire grants and subsidies, meaning the probability of gaining one is lower than other methods. 
  • Time-Consuming Process: Applying for these types of financial assistance is often arduous. It involves sifting through strict eligibility requirements, filling out long applications, providing additional documentation when needed, and waiting for a response for weeks or even months. 

The Process for Grants and Subsidies

Once you’ve settled on a grant or subsidy option for your company, you’ll need to prepare proper documents and be ready to answer a number of questions. This includes explaining why you need the funds, how you will use them, and what differentiates your company from others also seeking the funding. 

Ideal Situations for Grants and Subsidies 

Grants are a great option for small business start-ups that could use funding to get their company off the ground. Conversely, subsidies are beneficial for companies that are struggling to cover operating costs. 

Crowdfunding

Crowdfunding is perhaps the lowest-risk way of raising funds on this list and involves raising capital from people known as crowdfunders. Small businesses can ask for monetary gifts, and In return, they can offer rewards, such as a physical gift, products, or services, at a discounted rate to their funders.

Pros of Crowdfunding

  • Low Risk, High Reward: Besides administrative fees to crowdfunding sites, there is little financial risk to launching a crowdfunding campaign. If successful, your organization could boost funds tremendously without losing profits to investors.
  • Greater Audience Exposure: A crowdfunding campaign can expose you to a wide audience and, in turn, bring in potential new customers. Moreover, you can build a community with this audience and receive valuable feedback on your company.

Cons of Crowdfunding

  • Extensive Preparation Time: Launching a crowdfunding campaign takes hefty preparation. It involves developing marketing promotions and advertisements needed before, during and after the campaign.  
  • Reputational Risk: Should you receive donations, you must limit any possibility of delays or difficulty in delivering rewards. Companies that do often face reputational damage or flack from online users. 

The Process to Start Crowdfunding

The first step to crowdfunding is finding the right site to launch on, with some of the most popular being Kickstarter and GoFundMe. Moreover, each crowdfunding site has strict rules and eligibility requirements that must be adhered to. Once you’ve decided, you must develop a strategy for your campaign and define your rewards process before launch. After you’ve published, you must market, advertise and spread the news to get the word out and start seeing donations. 

Ideal Situations for Crowdfunding 

Crowdfunding is a good option for startups to brand themselves and raise capital. At the same time, established businesses can benefit from crowdfunding when launching a new product or service or even a new business idea. Should an idea be very catchy and shareable on the internet, a viral fundraiser can get the job done very quickly while amassing a lot of interest across new potential customers. 

Choosing the Best Financing Option for Your Business

Now that you know about some of the best financing options out there for your company, it’s all a matter of making a choice. There are a few key strategies you can implement to help you settle on a final decision. 

Factors to consider when choosing a financing option

The first step to deciding on funding is to ask yourself the following questions:

  1. Is financing necessary for my business right now? Consider if you can bootstrap funding or if it’s necessary to scale growth at the moment. After all, financing is a big decision, particularly if you choose to go with debt financing or obtain a loan. 
  2. Do we have collateral to offer? Think about your assets – are you able to provide them as collateral if need be? 
  3. How much decision-making would I like over my company? Some financing routes require you to give up some control of your company, particularly equity financing. If you’re unwilling or unable to share the control with investors, ensure you don’t seek out this option. 
  4. How is our credit history? Take the time to examine your credit score and history. If your business hasn’t built enough credit, you will find it more difficult to secure a loan. 

Matching Financing Options to Business Needs and Capabilities

Remember, your business needs should dictate the type and amount of funding you seek out – not the other way around. Too many companies make the mistake of focusing on getting money before deciding what they need to do with it. Take the time to develop a funding strategy that outlines both your needs now and your predicted needs for the future. 

Additionally, consider what your business is capable of at the moment. While every company has goals for growth, it often takes time to reach those goals – sometimes years. Be sure to set your expectations in the now, and don't jump the gun on funding. 

The Role of a Financial Advisor

Deciding on financing can be a daunting task on your own. If you aren’t sure what type of financing is best for your business, what you can truly afford, and what legal requirements you must follow, consider hiring a financial advisor. An advisor can help assess the financial standing of your organization and make recommendations based on your short and long-term goals. Not to mention, most of these agreements are not ones you should be preparing yourself if you haven’t had extensive experience in the matter. 

Preparing for Financing

Once you’ve answered questions about what kind of financing you need (and how much you can really afford), you’ll need to start properly preparing your application for funding. Here’s how. 

Improving Business Attractiveness

It takes more than a great idea to attract the right investor or lender to your business. To show investors that your business will provide them with a strong return on investment (ROI), you can also maximize attractiveness by: 

  • Come in with a detailed plan: Many business owners can paint an amazing big picture but are stumped when it comes to the small details. Always come into any meeting with a detailed plan that outlines set milestones, key performance indicators for success and ways to ensure accountability. It’s often what’ll set you apart from your competitors, as so few take the time to create a tangible plan.
  • Be open to change: While confidence in your vision is imperative, so is your willingness to be open to new ideas, change and the possibility that your way isn’t always the best way. Present yourself as someone who plans to grow in alignment with your company.
  • Highlight your greater purpose: What can your organization do not only for your market but for the world? Consider how your company currently offers solutions to larger problems, whether in society or the world itself. Doing so will reflect your passion and determination, which are always two traits any investor or lender will look out for. 
  • Show strong financial operations: Investors want to know they can see the financial information when needed and not have to wait weeks for the data. Keeping financial visibility into the strong performance of the company will help investors feel great while allowing the business to focus on itself. 

Preparing Financial Statements and Business Plans

Financial statements and business plans help ensure your company is sustainable and gives insight into your financial health. You’ll be better equipped to make sound business decisions and prove your attractiveness to potential investors or lenders. 

Financial statements usually include income statements, cash flow projections, a balance sheet and a statement of changes in stockholder’s equity. You can read more about financial statements here – including seeing some examples for yourself.

A well-written business plan is a document that proves your value to potential lenders by effectively explaining how you will make a profit and why it is likely to succeed. Most business plans contain the same sections: an executive summary, products and services, a company overview, market analysis, marketing and sales strategy and financial planning. Of course, business plans will vary from company to company depending on what it offers. 

Preparing for Meetings with Potential Investors or Lenders

Too many business leaders are under-prepared for their meetings with potential investors and lenders. As a result, they find themselves stuck when having to answer tough questions about their business. Instead, prepare yourself by taking the time to do research both on your own business and on your investors/lenders. 

Have answers ready for questions about your business growth plans, your main differentiator from your competitors, the qualification of your employees and your revenue as it stands now. Be sure to also look into your possible investors, researching what kind of companies they typically invest in and their criteria for investment. Doing so allows you to tailor your pitch in a way that also applies to them. 

Additionally, be sure to have your paperwork ready and develop a pitch that considers your target audience, your company benefits and the vision you have for your organization. 

Understanding the Implications of Financing

Financing is something that should be carefully considered, as regardless of which option you choose, there are long-term implications. Here are some of the most common ones to think about. 

How Financing Affects Cash Flow and the Balance Sheet

Investors and financial analysts will look at your cash flow statement to see whether your business has generated cash from your financing or is using financing to fund its operations. This helps determine the financial health, risks and opportunities a business has. For instance, it can shed insight into whether an organization can afford to repay its debts or whether it could take on further investment opportunities. 

However, a cash flow statement is not the only thing lenders, bankers and investors will look at for your financial health – they’ll also examine your balance sheet. While financing typically improves your cash flow, it also increases your liabilities on your sheet. 

The Impact of Financing on Ownership and Control

The type of financing you pick can greatly determine the amount of control you keep over your business. Equity financing often gives you the least amount of control, as investors become shareholders and owners. On the other hand, debt financing does not dilute ownership, ensuring business owners keep their freedom while making management decisions. 

The key question to ask is: how much control are you willing to give up? 

Legal and Regulatory Considerations

Legal and regulatory factors are also big considerations and can also further impact control and ownership. Some of the most common legal and regulatory points of concern include securities regulations, corporate governance and contractual agreements when selling shares to public and private investors. It’s always a good idea to consult a legal professional when undergoing financing agreements to make sure your business stays compliant and avoids legal issues down the road. 

Mitigating Risks and Challenges

Of course, financing comes with its own risks and challenges that, when not addressed correctly, could affect your company’s financial standing and even its bottom line. Here are the ways you can ensure you remain secure as you seek out financing: 

Meeting Obligations and Expectations

Meet your financing requirements, and you can help build long-lasting relationships that encourage your long-term success.  Here’s a quick checklist of how you can always make sure you meet what’s expected of your business:

  • Make all required repayments on time, every time.
  • Have regular financial reporting meetings to ensure transparency to investors and lenders, including your financial, income and cash flow statements.
  • Adhere to all covenants or conditions laid out by lenders, which could include assets to debt ratio or debt to equity ratio. 
  • Make certain you have a long-term strategy that considers any risks that make it difficult for you to meet your financial obligations. 

Avoiding Distractions from Core Operations

Distractions are inevitable in the business world – but they are also controllable. The key first step to having control of them is to define your core operations or the activities that contribute to your goals. Then, determine what might be distracting you from your ambitions. Is it time management? Imbalanced power of projects? Unclear priorities? Answer these questions and you’re one step closer to achieving success. 

It's helpful to identify tasks that are non-strategic to be able to choose which activities can be outsourced. Activities like bookkeeping, invoicing, expense management, payroll and taxes can be tackled with external partners at a more cost effective rate than hiring someone internally.

Securing Financing at Acceptable Terms

To meet your funding needs while ensuring favorable conditions, you need to secure financing at acceptable terms. Make sure you take the time to do your research, create a solid financial plan, compare offers and speak with professional advisors when needed. 

Financing is Possible. Tackle it with Confidence.

And there you have it – everything you need to know about financing for your small business. Ultimately, deciding which financing option is best for you all comes down to having a firm understanding of your business needs, goals and –yes – vulnerabilities. Self-awareness is a key trait of any successful business in the modern age.

There’s a lot to consider regarding finances, and it helps your business have the right support along the way. Luckily, Decimal can alleviate some of your financial processes by taking care of the smaller financial stuff, including accounting, bookkeeping and payroll. We’ve gone through fundraising and understand what investors need to see to feel comfortable making investments. Just look at our track record to see why strong financial operations are a major element in raising funds. 

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