How to Finance Your Small Business Using Debt or Equity

Financing your small business may seem like a daunting task. However, there are more options when it comes to small business financing than you may think. From the debt financing of banks and other professional finance institutions, to the equity financing of angel investors and venture capitalists, the possibilities are numerous. Some businesses may even qualify for a small business grant. Learning of these options will help you to determine which solutions could be viable for your business venture.

Typically, entrepreneurs will first turn to debt financing from their bank, savings and loan, or credit union when it comes to funding their small business. Debt financing refers to any funds that are borrowed. Financial institutions will loan money based upon your credit history, the collateral you have, and your character, as well as your business plan. These elements help the lending institution to determine your ability to repay the loan. To help reduce the risk on the part of the financial institution, the U.S. government guarantees certain loans by way of the Small Business Administration. By guaranteeing that the loan will be repaid in the event that you default, banks are able to loan money to entrepreneurs that otherwise may not have qualified.

Another option is that of equity financing. In this instance, financing is based on the equity in your business and is traded for a portion of your profits. Shares of your company are sold in the form of stock options to private investors such as an angel investor or a venture capitalist. It is important to keep in mind that in order to be eligible for this type of financing, you must be prepared with a solid business plan that demonstrates that your business is economically viable. Due to this fact, equity financing is more commonly sought after during the growth stage, once a business has had a chance to develop some history.

Although grants are few and far between, for specific types of businesses, they can be worth pursuing. Typically, grants are funds given to select businesses and generally do not have to be paid back, making them highly sought after. Funds are limited due to the fact that they are generated from our tax dollars. However, someone must be the recipient of these appropriated funds, so it is worth it to apply. Grants are written for various types of businesses such as those that benefit the environment, or community, or those that further research. There are also grants created for certain groups of people, such as minorities. If your business falls under any of these categories, you may qualify. Grants can be researched with your local, state, and federal government.

How to Garner Small Business Financing in a Dour Economic Climate

These are, without question, the worst economic times the country has faced in a very long time. And, especially given that the nature of this “Great Recession” was fueled in large part by a runaway credit bubble that eventually collapsed in on itself, it is little surprise that many people and businesses with good credit are finding it difficult to obtain financing for a variety of reasons. Whether your revenues are up or down, a loan at the right time can be just want your small business needs to take advantage of a growth opportunity, or to weather the current fiscal storm that is ravaging so much of the world’s economy.

One of the problems stems from the fact that banks and lenders are sitting on liquid money because they are deathly afraid of further economic contraction, coupled with the fact that there may still be a glut of foreclosures in the offing. Remember, all of those five year ARMs are one of the root causes of this bubble, and the peak year for signing ARMs by suspect home buyers was 2006. And those buyers in 2006 were among the shadiest, and the no look loans that they took out were among the worst both structurally and documentation wise. And then, of course, add five years to 2006 and what do you get?

That’s right, a fairly bleak home market and lending forecast for the year 2011.

With that said, though, there are a number of ways to obtain financing, but be forewarned that it will cost borrowers, even those with great credit, substantially more in interest than it ordinarily would. Also, there are number of government loan programs available, but depending upon your situation, that may be a worse proposition than taking out a high interest private small business loan.

And, remember that in hard economic times like this, do not take out financing to meet basic operating expenses such as payroll, operation costs or production costs. Use financing for expansion purposes, to purchase new equipment that will streamline the operations of your business, or if you can find a low enough interest rate, to transfer existing debt.

If you find that you need a loan to cover operating costs, strongly consider slashing your operating costs instead. Because, if business does not pick up, and I point to the 2006-2011 ARMs point referenced above, you will not only be stuck with the same bad financial situation that you are in now, but you will have the added costs of servicing the loan.

The New Wave in Small Business Financing

This is HUGE. This is tsunami in the making. Small business financing is on the brink of tapping into billions and billions of dollars that previously shut it out.

The signs are quiet. One venture capital firm announced that it had just funded an internet startup for $250,000. Another announced it had just brought in a new partner whose previous background was in angel investment. A third announced it would be sending a senior partner to a business plan competition.

Don’t get me wrong. Every one of these things has happened many times before. But this time it is different. This time they are announcing it.

One of the closest guarded secrets in venture capital is that venture capital firms do indeed make small investments, and have for as long as anyone can remember. These small loans are typically made to startups that just need a jolt of cash to get to the first stage, to give them breathing room to get a prototype made or have a marketing study completed. The venture firm typically takes a first option on future investments for these small investments, plus a bit of stock or interest or whatever.

The reasoning behind the small investments was never to make money, and these investments didn’t make money. If everything worked out okay, the small company could apply for significant venture funding when the time came.

Well, now there’s a new kid on the block.

This time the expectation is that these small investments WILL make a return, a goodly return in fact.

This time the small investments are aimed squarely at internet startups. That’s right – that industry that drove the venture capital industry to the dotcom disaster is back with a vengeance. Seems like the internet and venture capital are two lovers that just can’t stay away from each other for too long.

And this time it makes a lot of sense. Most internet businesses can begin easily with way less than a million in investment. Some need no more than a couple of programmers and a marketing person. With the right concept, the success comes rapidly and the internet business becomes self-sustaining in no time at all. And, if you take a look at the internet roster, you will see a long list of very successful companies that started on next to nothing.

This is the success that the venture capital companies are going after. Percentage-wise, there are huge profits to be made.

Smart venture capital companies are streamlining the application process. One, in fact, only requires the approval of one partner for investments up to $250,000.

The business plans for these internet companies will be like none other. No 200-page bound treatises here. Nope.

Short. Sharp. Nimble. A presentation that demonstrates the entrepreneur’s grasp of the industry and its rapidly evolving nature is the business plan of the day.

An online demo is essential.

And the power to turn all the equipment off and look the venture investor in the eye is also essential.

Those entrepreneurs who can provide vision and knowledge are sitting in a pot of jam. There are literally billions and billions of dollars waiting for you. Go get it.