As a small business owner, you likely have or eventually will run into the need for additional working capital. So how do you know where to turn? Should you try and take out a business loan or should you potentially look for a financing partner to work with? This decision is not one that should be made hastily. If you do decide to go with equity financing versus a more traditional commercial loan, you need to be aware of all that this entails. In this article, we will look at what should ideally go into choosing whether to work with a financing partner to raise money for your business or if it makes more sense to apply for business financing through a lending institution.
Raising Cash for Your Small Business
Especially if your business is relatively new, you may not have a huge supply of cash reserves on hand. And if you do have funding needs—be it long or short term---this could present a problem. You don't want to exhaust your savings and yet you may have limited options. This is where working with financing partners could potentially be a lifeline for your company.
What it comes down to for numerous business owners is the choice between raising capital via equity financing or debt financing. With equity financing, you are offering equity in the company in exchange for an investment. With debt financing, you are likely going to work with a lending institution to try and borrow the funds required. While both means of raising capital certainly have their upsides, it is crucial to understand the cons involved with both equity financing and therefore working with financing partners, as well as understanding the downsides to debt financing. Some entrepreneurs will utilize a combination of both to get the money they need for their business.
Selling Equity in the Company to Financing Partners
When a business owner sells shares of the company to raise more money, this is known as equity financing. Regardless of whether you're in the early stages of the business or have been around for some time, selling equity in the company is usually always an option. And to whom you sell the shares is also a consideration. You can sell to individual investors and you can also sell to larger groups of investors. Depending on the position of your company, you can either offer these shares privately or if your business is growing relatively fast, you might consider an offering to the general public.
When you do sell off shares in the business, you are giving the shareholders specific rights. These can include ownership of a percentage of the company, the right to dividends, and the capacity to look at the corporate books at their discretion, among other such rights.
Often when looking to sell equity in the company to raise the needed money, a small business owner may turn to a venture capitalist as their financing partner. For the most part, a venture capitalist will usually act as a silent financing partner. They will give the business an infusion of cash because they believe in the future profitability of that business. To this end, a VC might offer suggestions regarding the overall direction of the company and what can be done to ensure sustainability. They might insist on checking up on the business from time to time. And then, of course, there are those more active financing partners who do take a hands on role in terms of the day to day operations.
The pros and cons of having financing partners
There are upsides and downsides to equity financing and consequently working with a partner to this end.
On the plus side:
- You get the money needed without having to go into debt.
- Some financing partners will help as far as offering advice and even doing some work for the business.
- Depending on their level of involvement, it may free up some of your time.
On the downside:
- You will have to distribute some of your future profit based upon the percentage owned.
- You no longer have complete control over your business.
- Disagreements about how to run the company can arise and therefore spur tensions.
Debt Financing to Get More Capital
The more traditional way of raising money for your company is to approach a lender about a business loan. This way you are not having to give up a percentage of your company and you maintain complete control. As with equity financing, there are going to be both pros and cons to working with a bank or lender and taking on debt.
On the plus side:
- You do not have to relinquish any control of the business.
- There are more flexible ways/means of borrowing money.
- You can choose the financing offer that makes sense for you.
On the downside:
- You are now taking on debt.
- Depending on loan size, this could limit future loan amounts.
The question of debt versus equity financing and thus taking on financing partners is one that every business owner does need to spend some time thinking through carefully. Are you willing to give up equity in your company? Are you willing to give up some control? And of course, do you want to share your profits with financing partners?
In terms of applying for a business loan and going the debt financing route, you also want to think about whether or not this is a good fit for the business. Consider if you can make monthly or weekly repayments comfortably without feeling the crunch. Think also about whether this is the right time for your company to take on new debt. Both financing options have pros and cons. Which you choose is certainly an important decision and one that will ultimately impact your company moving forward.