There are Three Main Purposes of Financing
- Funding a business start-up
- Financing for the growth and expansion of a business
- Dealing with unforeseen financial encounters
Sources of Business Financing
- Self-Funding
- Giving up Equity
- Debt
An entrepreneur takes on debt to fund massive purchases that they could not afford under normal circumstances. A debt arrangement means that the borrower is given money under the condition that the money will be paid back later with interest. There are different types of funding:
- Business credit card use
- Small Business Administration loans
- Foreign investors
- Crowdfunding/selling shares of the business
An Entrepreneur Must Be Clear of the Situation and Considerations When Taking Loans
Consider the following when taking a loan
- How early are the finances needed? If there is no time to wait, then debt financing may be the only option left to invest in the business.
- How much finance is needed? If there is a small amount to be invested, a loan can be taken.
- If a company is running successfully and financing is required urgently, debt can be taken.
- Debt is beneficial if you want to keep the business local and keep the whole ownership with you.
- When taking debt, the lender has no claim to equity in the business. Ownership remains the same. Business operation and bookkeeping decisions remain with the owners/entrepreneurs/executive management.
- When net profit is increased, the lender will only be given the borrowed money and the interest in it. If business progress and rewards are more significant, the entrepreneurs will reap the rewards. The lender will not claim or share in the business rewards/profits.
- Interests on debt can be subtracted from the business’s tax returns. Borrowing money can be a gift to entrepreneurs. The cost of interest decreases the taxable profit that your business earns. Thus, it reduces the tax expense in your company/business. Large corporations/businesses also use this strategy to minimize tax expenses.
Consider options other than taking loans
- Debt has to be paid back with interest, whether the business is a success or not.
- High interest in debt during a recession of business can dissolve the company.
- The bigger the debt-to-equity ratio in the business, the riskier the business is considered by investors.
- The company is usually required to place assets of the company as security/warranty to the lender.
- If you are making day-to-day purchases and are small in numbers, then using a business credit card is the best option.
It can be a challenging duty of entrepreneurs to decide when and how business financing is right for the business. If the entrepreneur does not have enough money to be used as a capital investment, they may go to lenders to borrow money or take debts from banks or financial institutes. Starters in the business field are not experienced, and lenders will not give them an accurate picture. Getting loans in the wrong situations and at the wrong times costs financial losses to entrepreneurs.
Entrepreneurs must understand these essential factors before going to lenders
- Credit history: previously, how has the business financing been managed?
- Ability to pay back the loan: is the business going well enough to pay back the amount borrowed with interest?
- Has the entrepreneur invested enough personal finances as capital in the business?
- Does the business have assets to be put down as security in debt if the company fails or a period of double-dip happens?
- Does the entrepreneur have enough experience in business financing and business operations?
Conclusion
If entrepreneurs are not experienced, they can consult with bankers and accounting firms to get a clear picture of their business and when to take a loan. They can benefit from the advice of bankers as well.
Using the right tools and assistance at the right time for business financing is a way to a successful business.
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