There are different types of financing that an entrepreneur can choose from in order to fund a new business.

All such options are categorized, accordingly, into two groups: debt financing and equity financing, both of which have benefits and disadvantages for the entrepreneur. When choosing debt financing for a new business, entrepreneurs are simply acquiring a loan from a lending institution or government agency, such as the Small Business Administration. When they decide to choose equity financing to fund their venture, they are simply exchanging the amount of capital for a piece of ownership in the business. The latter type of financing is usually provided by venture capitalist and angel investors. Debt Financing Equity Financing Debt financing refers to any Equity financing is money lent in borrowed money which the exchange for ownership in a company. Definition entrepreneur must pay back to New businesses can use equity the lending institution. It can financing for their start-ups or when come in the form of a loan, they need to raise additional equity line of credit, bond, or even capital to offset existing debt. an IOU. An interest rate and other terms apply. Who depends on Companies which are well- Companies with a more conventional established and have approach to management, high this type of demonstrated steady sales, profitability, and/or poor credit ratings capital? solid collateral, and profitable often rely on equity capital for their growth often rely on debt funding needs. capital for financing their Ideal form of capital for small businesses. businesses start-ups and newly launched companies since they have not established a solid track record of success and face uncertainty in their early stages of development. Commercial banks Personal funds (bootstrap finances) Where can I can be obtained from savings, credit obtain this type Loans through the Small Business Administration cards, retirement accounts, property of funding? (SBA) equity, etc. Friends and family can lend money for a stake in the company. Angel investors and venture capitalists can also provide a new business owner with desired capital in exchange for a board seat, a stake in the company, and large return on investment. Investment banking firms Insurance companies Large corporations Government-backed Small Business Investment Corporations (SBICs) Low Debt-to-equity High (ideally, 1:2 or 1:1, depends on industry) ratio Exceptional credit history of Good-standing credit history Requirements borrower. Borrowers must demonstrate their Borrowers must show company is in a high-growth industry

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Disadvantages

Credit check

Term options

potential lenders they are and there is a potential to produce a willing to invest money in the large return on investment. business by using their own Well-detailed business plan and clear money. exit strategy. Lender does not gain Allows the entrepreneur to obtain ownership; therefore, the funds without incurring debt = more entrepreneur is able to cash flow. This will allow business maintain maximum control owners to focus their attention on over their business. making their product(s) profitable The borrower has no rather than paying back the investors. obligation to the lender other Enables the investor(s) and business than the repayment of the owner(s) the opportunity to develop a loan; their relationship ends long term relationship throughout their once the entire amount is paid joint business endeavor. back. The cash flow generated can be used The interest on debt for follow-on investments rather than financing is tax deductible. towards the loan debt. Depending on the terms of Capital borrowed from family and the loan, repayment of the friends is a quick way to raise capital loan is often a fixed, monthly with no overbearing interest rates. expense. The business will not have all of its cash flow available to do business Requires regular monthly Dilution of ownership can easily payments with steadily occur; the more investors involved, accrued interest = limited the more loss of control. cash flow. Angel investors or venture capitalist Tarnished credit ratings can may feel inclined to have a say in result from the inability to every business decision. pay back any borrowed If capital was obtained from capital, limiting the chances bootstrap finances, credit cards may of raising additional capital. be maxed out. If money was borrowed Often limited to established from family and friends, then businesses with a solid track relationship strains may occur. record of success. Too much equity can suggest that entrepreneur are not making use of their borrowed funds; whereas too little may demonstrate noncommitment on the company owners part. Complex reporting is often required by investors. Yes. The higher the credit Angel investors and venture scores of the company capitalist will usually conduct a credit owner(s), the better the check of the business owners during chance in obtaining a loan. the due diligence process but may rely more on the potential of return on investment. Family and friends usually do not conduct a credit check. Short-term debt financing: Usually, both angel investors and

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total repayment of borrowed capital in less than one year. Long-term: total repayment of borrowed capital in over one year. A type of long-term debt financing payment is a balloon payment, whereby the end of the term the lender and borrower negotiate a new loan amount for the residual amount left. Variable rates usually occur with long-term debt financing, where the interest rates are adjustable by the lender according to market performance.

venture capitalist are involved in an investment for an average of 3-7 years. Companies can also opt to obtain equity financing by selling company stock to employees, Employee Stock Ownership Plan (ESOP), sharing control of the company with them rather than with outside investors.