In today’s ever-changing small business world, founders need reliable funding to realize their ideas. Many businesses seek outside help to get the money they need, whether for the initial launch or to help with growth. There are two main ways to get funding: debt and equity which are the major types of financing in small business and medium sized business orgazinzations.
Both have pros and cons, depending on what your business is trying to do and how much risk you’re willing to take. In this article, we’ll compare and contrast these two main funding options to help you make the best decisions for your business. By understanding their differences, you can make better decisions to help you grow your business for the long haul.
Financial Alternatives – Types of Financing in Small Business (Debt And Equity)
There are two main types of financing from external sources: equity and debt. Equity financing is giving money in exchange for some ownership and future profits. Debt financing, on the other hand, is when you have to pay money back, usually with interest.
Debt Financing
Debt financing is where companies get money to cover different business expenses by issuing debt and borrowing money from banks or other lenders. Debt financing includes bond issues, business credit, term loans, P2P lending, and invoice factoring. Some of the most common types of debt financing are:
Bank Loans
A bank loan is one of the most popular types of finance for SMEs. A bank will offer to lend money to you for a certain amount of time. As part of the loan, you’ll have to pay a set amount of interest every month or year.
Small Business Administration (SBA) Loans
The Small Business Administration (SBA) guarantees a portion of these loans, making them more accessible to small enterprises. Initially started in the USA, many nations have started the same policy. SBA loans’ conditions and loan-to-value ratios are more favorable than conventional loans.
Lines of Credit
A line of credit is like a loan from a bank or other financial institution that gives you a certain amount of money you can use whenever you need it. You can use it immediately or pay it back over time with regular minimum payments. You’ll have to pay interest on the money you borrow right away.
Credit Cards
It’s a loan given to you by a bank or another financial institution. It’s a set amount of money you can use when you need it, and you can use it immediately or pay it off over time with minimum payments now and then. The only thing you have to pay is interest on what you borrow.
Equity Financing
Equity financing is when you sell your business shares to investors for money. In this way, investors become part of your business. You don’t have to give up control since your investor can still take a small interest. There are a few basic types of equity financing:
Angel Investors
Angel investors are high-net-worth private investors looking to invest in small businesses. Unlike venture capital firms, they use their net worth to fund their investments. They invest in early-stage companies and get an ownership stake in the industry.
Venture Capital (VC) Funding
Venture capital (VC) is when investors buy shares in start-ups or small businesses that they think will do well in the future. Big investors, banks, or other financial firms usually do it. They buy shares in the company and get involved in how it operates, and make decisions.
Crowdfunding
Crowdfunding is when you get a lot of money from many people (fundraising), usually over the Internet. It’s a way for entrepreneurs to get a small amount of money from many people who believe in their actions. Depending on what kind of crowdfunding you’re doing, you might earn rewards or equity for doing it.
Initial Public Offering (IPO)
An IPO is when a company sells securities to the public. It’s the most significant source of money for a company with long or no time limits. When a company gets access to capital through the public market, it becomes more susceptible to becoming established with a track record of success. It involves selling shares to the public on a stock exchange.
Strategic Partnerships
Sometimes, small businesses team up with more prominent companies that want to invest in them to get into new markets or tech. Financial partnerships involve stock plans, accounting, benefits, and so on. Usually, when companies use accounting services from another firm, it’s called a strategic financial partnership.
Combination of Debt and Equity Financing
Debt-equity financing, or hybrid financing, is a way for companies to get money for their business or projects by using debt and equity. Instead of just using one type of financing, companies use both to get the cash they need. This way, they have a more flexible and balanced capital structure.
Examples Related to Types of Financing in Small Business
Debt Financing Example
*Company: SweetBake Bakery*
Small, artisanal bakery SweetBake makes delectable delights. They loaned money to open a second business in a great neighborhood. A local bank gave them a $50,000 business loan with a low-interest rate and five-year repayment. They borrowed money to buy baking equipment, recruit more staff, and redecorate their new business. The expansion increased output, customers, and revenue. They expanded and paid off the loan fast.
Equity Financing Example
*Company: TechGenius AI*
TechGenius AI, an AI software company, needs money to grow and accelerate research. They chose stock financing for considerable money. After pitching their AI solution to a top VC, they received $3 million. They received 20% of TechGenius. TechGenius AI expanded its AI research and engineering workforce, product lines, and relationships with prominent industry brands with the money. VC company skills and network opened new markets and clients. With more substantial value and market presence, they pioneered AI software.
Combination of Debt and Equity Financing Example
*Company: GreenTech Solutions*
GreenTech Solutions marketed eco-friendly home products. A $100,000 online small business loan helped them establish a factory and launch their first line of products. Angel investors gave them $150,000 for 15% equity to build their firm. Debt and equity financing paid for marketing and product development. Environmentalists liked them.
Conclusion
Different types of financing in small business consist of equity and loan finance. Debt financing maintains business control, but you must make a profit. Equity finance gives you a lot of money without any problems, but you have to share ownership and decisions. Consider all financial options for business success. Consider your risk tolerance, business growth, and performance. Ask investors and lenders about business financing options. Strong little enterprises succeed. Debt and equity may boost your business.
References
- Debt financing: How it works, types, pros & cons. NerdWallet. (n.d.). https://www.nerdwallet.com/article/small-business/debt-financing
- Egan, J. (2022, September 13). Debt financing vs. Equity Financing for Small Business. The Balance. https://www.thebalancemoney.com/debt-and-equity-financing-393248
- Equity financing. Corporate Finance Institute. (2022, December 10). https://corporatefinanceinstitute.com/resources/valuation/equity-financing/
- Financing options for small businesses – small business administration. (n.d.). https://www.sba.gov/sites/default/files/TRANSCRIPT_Financing%20Options%20for%20Small%20Businesses_0.pdf
- George, S. (n.d.). Small business financing: Your options. Bankrate. https://www.bankrate.com/loans/small-business/small-business-financing/
- Qureshi, A. (2022, December 2). Alternative financing: What it is & how it’s changing the funding landscape. Capchase. https://www.capchase.com/blog/alternative-financing
- Wikimedia Foundation. (2023, February 1). External financing. Wikipedia. https://en.wikipedia.org/wiki/External_financing
- Woodward, E. (n.d.). Debt vs. equity financing. Bankrate. https://www.bankrate.com/loans/small-business/debt-vs-equity-financing/
This is Tabassum Nusrat Soti and she is a content writer from Bangladesh. She has been a professional writer for over 5 years now. and she has been working with The Strategy Watch for over 3 years now.
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