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Business Finance Guide
Finding financing for a new or existing business could be one of the most difficult and most important issues facing any business owner. Without adequate financing, a business may not survive in the long term, so this issue is one that business owners may continue to consider for as long as the business operates.
Why do businesses need to raise financing?
All businesses need money to operate, and usually require access to cash as well as other types of funding. Financing could allow for the purchase of stock and equipment, payment of rent for business premises, and salary or wages for employees. Without an initial source of financing a startup may never get off the ground, and without consistent financing and income, a business might struggle to survive and may ultimately fail.
What Types of Business Financing are Available?
There could be many different ways in which a business may raise financing for short-term and long-term operations. From startup funds from friends, family, or investors, to loans for small business expansion, a business owner tends to have a wide array of options for obtaining financing. Some types of financing may be more expensive to obtain than others, of course, so if the objective is to find cheap business finance it’s probably important to carefully consider all the options before making a decision.
Loans from Friends and Family
One of the most popular ways to start a small business tends to be to use personal savings, or loans from family and friends, as a source of startup funding. There may be plenty of advantages to this kind of funding. A person doesn’t typically have to worry about references or credit checks, and don’t have to provide any kind of security for the loan. And someone might get an interest-free loan and therefore could save a significant amount of money in comparison to financing via a small business loan from a bank. The downside to this approach is that borrowing from people that are close could potentially cause a rift in the relationship if someone is unable to pay the money back on time or if there’s a misunderstanding about the terms of the loan. To reduce the risk of problems, it could be important to treat these kinds of loans as someone would a loan from a bank or other financial institution, by drawing up a contract that sets out the terms of the loan and repayments.
When it comes to bank financing many people think a loan is the only possibility but in fact there may be a couple of ways to obtain financing from a bank. However, each kind of financing is best used in certain specific situations. Typically, an overdraft is most useful for providing flexible day-to-day funding while a bank loan could be a good way to obtain funds for a large purchase or other significant expense. Bank loans may typically be used for major expenditures that add value to a business or that contribute startup funds. Loans for small business financing most often have a term of 3 to 10 years with a fixed or variable interest rate. Overdrafts for small business financing could be a good way of keeping cash flow going on a day-to-day basis, especially for businesses that tend to receive income at irregular intervals. With an overdraft the business may only be charged interest on money it borrows, however there could be caveats. For instance, some banks do have flat fees for overdraft use. Another potential problem could be that a bank could demand payment of an overdraft at any time, whereas this is not usually the case with a loan.
This kind of financing is not usually widely used, but could be an effective way for growing businesses to obtain funds. There may be two possible methods a business could use: invoice factoring and invoice financing. Invoice factoring involves a business passing on their invoices to a third party. The third party pays the business a portion of the value of the invoices, and becomes responsible for ensuring the invoices are paid when they come due. Once the invoices are paid in full the third party pays the amount outstanding, less fees for administration and interest. Invoice discounting is similar, but rather than passing responsibility for the invoices to the third party, it remains with the business. The third party lends money based on the value of the invoices, and the business pays it back when the invoices are paid. These could be effective ways of generating cash flow in a business that relies on invoicing, but it’s usually important to be fully aware of all associated administration fees and other costs to prevent unpleasant surprises.
In this situation the owner of a business may sell a portion of their business interests to an investor. The investor then owns part of the business, and takes a share in the profits, as well as a share of the responsibility for losses. This could be a good method of obtaining startup or expansion funds, particularly as no money needs to be repaid. However, a small business owner who opts for this method of financing should be aware that an investor might require them to consult on future business decisions, depending on the nature of the agreement they make.
Also known as peer to peer or P2P lending, crowdfunding could provide a business with a source of funding to develop and launch a new product or otherwise expand. In a crowdfunding arrangement, a business owner typically creates an online presentation on a crowdfunding website, and interested investors pledge their financial support. This may be less expensive than obtaining a bank loan, but it’s still important for a business owner to investigate what kinds of fees they’re expected to pay for the use of the crowdfunding platform they choose. Depending on the platform the fees may be as high as 7%, so this should be taken into account when developing a presentation.
There may be several different kinds of grants that the government makes available to new and existing small businesses. These tend to have fairly strict application requirements but could be an excellent source of funding for people who qualify. Another particular advantage is that grants do not need to be repaid.