There are numerous financial tools available to help entrepreneurs fund and grow their businesses. This is a positive thing, but such a vast array of options can make it difficult to determine which tool best fits your particular funding requirements. Below is a list of things to consider as you choose the best business financing method for your business.
1. Type of funding.
There are two kinds of money: debt (borrowed funds) and equity (funds traded for ownership of the company.) The first important financing decision you will make is whether you will rely on debt or equity. This usually depends mainly on personal preference. For example, if you want tight control over the ownership of your company, you might choose debt instead of equity. On the other hand, if your company has few assets to use as collateral, it may be more practical to choose equity over debt. For maximum growth opportunities, consider financing your business through a combination of debt and equity.
When deciding the best business financing option, consider whether you’re looking for long-term money, short-term money, or both. Businesses are long-term investments, so the capital raised to purchase one should be a long-term endeavor. Equity is the easier way to satisfy this requirement, as investors don’t usually demand repayment until the business is firmly established. Debt is also a long-term option; long-term loans are another way to obtain capital. On the other hand, long-term money isn’t always the right choice; if a fast-growing business needs immediate cash to meet payroll obligation, purchase supplies, etc., short-term loans and lines of credit are a more logical solution.
3. Return on investment.
Debt and equity both come at a price. With most loans and other forms of debt, that price is paid in the form of interest. Equity is purchased at the cost of shared ownership and the loss of a percentage of the business’s total value (which will be paid to investors); for this reason, equity usually turns out to be the most expensive financing option. You should choose the business financing option that will cost less than the return you expect from it. In other words, only invest money in a project that will result in high enough income to cover loan payments and other obligations while still leaving enough room for profit.
When starting a business, you have to spend money to make money. No matter which financing option you choose, however, you shouldn’t spend more money than you make. Remember, strong financing makes for a strong business.