Last week we looked at Small Business Funding and talked about the ins and outs of Equity Financing. Today we’ll continue down the road of company financing and explore the avenues small businesses navigate in order to arrive at the funds needed to grow their business.
From Equity Financing to Debt Financing
While equity financing involves the injection of funds without the perils of interest, other payback methods are expected in return. In other words, this form of money sharing is by no means like a handout; although it is certainly an instrument of good faith. Angel investors and venture capitalists hope for the success of your company and expect to be rewarded with a percentage of future profit.
For more information on investor return check out our blog post on Understanding Investor Required Return
Should a company fail, funds obtained through equity financing are not expected to be paid back. However, a prosperous company may end up paying a great chunk of change back to their investors with an equity stake. In addition to stake in future profits, these equity investors have the authority to voice their opinions about business functions, a point that cannot be overlooked.
So, What’s the Deal with Debt Financing?
In a sense, debt financing can be a more perilous choice than its equity counterpart. Should a business that received funds through loans fail, the company is liable to pay this back, possibly plus interest. The good news about debt financing is that from the inception any deal the figures are codified and set in stone (or written in a contract).
Who uses Debt Financing?
Everyone. Debt financing is used across the board. Maybe you are a fresh faced CEO of a startup looking to make it through your first financing round, or are a big business strapped for cash during an economic downturn, or perhaps you’re an SME looking to grow your business and you just need a little cash to fertilize your money tree.
At Equidam we are most concerned with the perspective of small business, with companies who might want to grow their business. Let’s take a minute to explore possible kinds of debt financing, brought to us by NerdWallet.
Trade Credit
Trade credit means your company will make purchases on credit; to pay back at a decided upon date in the future, hopefully when you are more financially able to pay. In accordance with our trusty friend Investopedia, Trade credit payback periods are generally 30, 60 or 90 days.
Loans from Family
Family may be the answer to a cash influx need. Family is perpetually investing in itself, and relatives may be willing to offer financial support. These agreements are generally built between parties with a sense of trust that has already been developed, making payment schedules lenient.
Factoring
Factoring occurs when a company sells a portion of its accounts receivable in order to get cash money right away. This is a more immediate solution for funds. Later on, companies that purchased the accounts receivable will be paid back in full by customers of the borrower.
Bank and Credit Loans
This (modern) age-old manner of debt financing involves scheduled payments. Credit history is a key factor in determining loan approval and interest rate.
Overdraft Lines of Credit
As explored in Debt Financing: The Definitive Guide for Small Businesses, this method of borrowing involves a contract between a company and bank. Funds can be withdrawn up until a bank-specified point. The principal and an arbitrary amount of interest must be paid back.
And therein lies the magic of debt financing. Stay tuned for our Small Business Funding Series and leave comments below! Now that we’ve discussed prime examples of debt financing for small businesses, how might you use this information to grow your business?