Small Business, Finance

3 questions to ask before financing your business

BY Guest Contributor 4 Nov, "16

The idea of an extra $50,000, $100,000, or perhaps even more cash, at your fingertips sounds glorious, right? Acquiring external capital — and being able to utilize those additional funds to invest into improving your business — is an exciting prospect for any small business owner. That is, until you’re face-to-face with the harsh reality of an overwhelming number of options, terms, minute details—or even, perhaps, huge bills.

But, believe it or not, financing does not have to be complicated. By answering these key questions, you should have a clearer picture of what’s right for you:

  1. Does your small business need financing?
  2. What’s the difference between debt and equity financing?
  3. Which type of debt or equity financing is the best fit for you?

blog-header-161103.jpgDoes your small business need financing?

First and foremost, external financing is not the right solution for every business need. That doesn’t mean never —  it just means that you need to evaluate the necessity of external capital with your company’s current needs (and limitations) in mind.

So, how do you determine if financing is the right move for your small business? The difference comes down to return on investment (ROI). ROI measures the return on a specific investment compared to the cost of that investment. If you utilize the funds you raise toward an expense that will generate growth or revenue, the investment will have a positive return on investment (and vice versa). This means that repainting your office walls — something that will not generate revenue — is not the best choice in how to deploy your funds.

Regardless if you’re asking for an investment from friends and family, or applying for a small business loan, you should have a clear idea of how that expenditure will contribute to growth. Investments that you can expect a positive ROI from include hiring employees, opening a new retail space, purchasing inventory or equipment, refinancing debt and solving short-term cash flow fluctuations.

So, before you go down the road of seeking financing, remember to ask yourself: “Would this expenditure have a positive ROI and help grow my business?”

What’s the difference between debt and equity financing? Which type of financing is the best fit for you?

Equity financing involves trading a piece of your business for upfront capital. You get the funds now, and the investor — often taking the form of friends or family, angel, venture capital or private equity — get a share of the company profits later (as well as often, a say in the trajectory of the business).

The advantages of equity is that there is no age requirement. Companies receive capital at an early stage without much existing operating history, and often times, without being profitable. In fact, there is no revenue prerequisite to securing equity financing. And because there are no immediate payments, it is not necessary to maintain a steady (or sufficient) cash flow. This gives owners the leeway to focus on longer-term strategies. However, raising 3rd-party capital means giving up ownership — and a portion of future profits — of your company. Your decision-making power becomes diluted, and quite often, your vision.

Debt financing, which includes small business loans as well as credit cards, is the counterpart to equity financing. Debt financing involves borrowing money from a lender to pay back in the future. The upside of debt financing is that you receive capital to grow your business with no strings attached (except the interest you pay on the capital borrowed). No matter how much you borrow, or what form of debt financing you choose, your ownership remains completely intact. So, what’s the risk? Well, it depends on your ability to repay. However, assuming you allocate your funds to something with a positive return on investment, paying back what you borrow should not be an issue. Debt financing is also typically not possible for pre-launch or pre-revenue businesses, as lenders often require operating history and profitability to evaluate your riskiness as a borrower.

Depending on your business’ type, growth stage, and needs, the following types of debt financing are available:

Each type of debt serves different use cases. As an example, at Bond Street, intermediate-term loans are our specialty. We seek to fill the gap between banks and alternative lenders by providing loans of $50K-500K over 1-3 year terms to businesses with at least 2 years operating history and $150K in annual revenue. These loans are often geared towards longer-term growth investments. Whereas if you’re looking for short-term flexibility — and are able to repay your expense within at most 12 months — a line of credit might be a better fit for your business.  

Next Steps

We hope that now you have a better idea of when and how to finance your small business. Before applying for financing, remember to keep in mind these steps:

  • Take stock of your business history and current needs. Is financing right for you?
  • Debt vs equity: which fits your business best? Consult with an advisor, and do some additional research to be 100% positive.
  • Choose 2-4 lenders/investors who offer the appropriate kind of funding to compare. Evaluate the terms, fees, and long-term consequences of your options.
  • Finance the growth of your business!

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See also:

The inventory value of your stock: making sense of FIFO, LIFO and WAC

What accountants aren’t (and should be) asking small business clients about their inventory management procedures

The total cost of inventory for your business: what it is & why you should know it

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