For most people familiar with finance, financing investors seem foreign language. The idea of working with an “incomplete asset” or entity is foreign to most people. But for the average investor, financing investors means simply buying shares or assets sold at auction. It may sound simple – but it’s not. Finance is complex, and it has a lot to do with how you plan on using the funds, your risk tolerance, and what you expect to earn back.
Finance can be broken down into two major categories: revenue-based financing and capital-based financing. Revenue-based financing is used when you are simply raising capital. On the other hand, capital-based financing is when you are looking to buy, construct, or repair the property. Either type of financing may be used for different projects, but it’s important to understand their differences. As with any loan, you will want to weigh the costs and benefits before making any decisions.
Debt Financing: Debt financing is a popular option for many small business owners. Debt financing allows the owner to obtain credit for the amount needed for the start-up and growth of the business. Typically, third-party lenders offer debt financing that has placed a lien on the property for this purpose. Debt financing can be effective for many small business owners. The primary benefit is the availability of capital to make the first few years of business profitable.
Growth Capital: Growth capital is a non-recourse loan. In other words, the borrower is offering the lender a guarantee that they will make the interest and payment on the loan. This is often done in the form of a lease. Since growth capital is nonrecourse, the monthly payments and interest rates are typically low. Additionally, since growth capital is not collateralized, there is little or no risk to the lender.
Equity Financing: Equity financing refers to offering potential equity partners (shareholders) a percentage of the business. Small businesses must meet certain requirements to qualify for equity financing. However, since equity partners do not have to register as stockholders, they do not have the same risks associated with ownership. Equity partners usually receive a small percentage of the business.
Small Business Loan: The most common form of small business financing is a secured loan. A small business loan can be provided by many financial institutions such as banks, credit unions, private investors, and mortgage companies. Many borrowers use equity financing to raise capital. To apply for small business loans, potential borrowers need to complete application forms that answer their personal credit history and financial history questions.
Revenue-Based Financing: Revenue-based financing is used for many businesses. Revenue-based financing allows small business owners to obtain the money they need to purchase equipment, supplies, and property when they make sales. Many investors use revenue-based financing to raise short-term funds. They then repay the investor when they make their sales and get paid a dividend.
To find financing investors, potential business owners may contact the Small Business Administration, Inc., the United States Department of Agriculture’s Small Business Administration. This agency provides funding to help entrepreneurs achieve and maintain their goals. The SBA works closely with investors to ensure that the company they are financing meets investment criteria. Once an investor confirms that the company will meet the investment criteria and will be able to repay the investor within the time period outlined by the agreement, the investor may obtain a full-risk or preferred financing from the SBA.
