Small Business Financing

Small business financing refers to the means by which an aspiring or current business owner, entrepreneur, obtains money to start a new small business, purchase an existing small business or bring money into an existing small business to finance current or future business activity.

There are many ways to finance a new or existing business, each of which features its own advantages and disadvantages.

There are two traditional main options available to aspiring or existing entrepreneurs looking to finance their small business: borrow funds (debt financing), or sell ownership interests in exchange for capital (equity financing).

Debt Financing

The principal advantage of borrowing funds to finance a new or existing small business is that the lender will not have any say in how the business is managed and will not be entitled to any of the profits that the business generates. The disadvantage is that loan payments may be especially burdensome for businesses that are new or expanding.

It is important to point out that failure to make required loan payments will risk forfeiture of assets (including possibly personal assets of the business owners) that are pledged as security for the loan.

Entrepreneurs should realize that the credit approval process may result in some aspiring or existing business owners not qualifying for financing or only qualifying for high interest loans or loans that require the pledge of personal assets as collateral. In addition, the time required to obtain credit approval may be significant and could potentially slow down the small business venture’s operationality.

Should debt financing become excessive, it may overwhelm the business and ultimately risk bankruptcy. For instance, a business that carries a heavy debt burden may face an increased risk of failure.

Sources of debt financing include: conventional lenders (banks, credit unions), friends and family, technology-based lenders, microlenders, crowdfunding, and personal credit cards.

Equity Financing

The major advantage of selling an ownership interest to finance a new or existing small business is that the business may use the equity investment to run the business rather than making potentially burdensome loan payments. Moreover, the business and the business owner(s) will typically not have to repay the investors in the event that the business loses money or eventually fails.

It is worth noting that by selling an ownership interest, the entrepreneur will dilute his or her control over the business.

Investors who become part-owners of the business are entitled to a share of the business profits.

In this type of business arrangement, investors must be informed of significant business events and the entrepreneur must act in the best interests of the investors.

Sources of equity financing include: friends and family, angel investors, and venture capitalists.

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