Financing a Business & Relevant Legal Considerations
Key to the success of any business is the development of reliable sources of income. Once your business is fully operational, this may be relatively straightforward as your customers pay you for the goods or services that you provide to them. But what about when you are just starting your business and need money to simply open your doors? In this situation, most small businesses turn to either equity or debt financing. While seeking out financing may seem obvious, the process itself can often make or break a business. Before beginning to apply for the money that you need, it is important to first consider the available sources and what might work best for you.
Evaluating Your Financial Needs
Before seeking out funding from banks, investors, or family, it is important to first honestly evaluate your finance needs and the type of business you are hoping to create. For instance:
Do you simply want enough financing to cover your existing needs, or are you hoping to secure financing that will cushion you against unexpected events and carry you into the future?
Can you carefully articulate your financing needs to interested investors or banks?
What financial risks does your business provide? How will that affect your financing?
What are your projections for future growth? Do they meet the current state of your industry?
These are all important questions to consider in preparation for financing applications. You can anticipate that potential lenders and investors will carefully and thoroughly critique your financial requests and current financial status as part of their vetting process, so it is in your best interest to be prepared to answer tough questions.
Sources of Financing
Business financing takes two primary forms: debt and equity. Debt financing is money that you have borrowed from a bank, family member, or friend to help finance your business. Equity is money that you have invested in your business. Generally, as with all financing, it is helpful when your business has a strong equity to debt ratio. The higher your percentage of existing debt, the more difficult it may be to secure additional funding.
If you are just starting out, obtaining a business loan from a bank is a perfectly acceptable means of financing, and small business loans are quite common to the banking industry. You may also be able to obtain debt financing through state and federal government programs, such as lending programs administered by the Small Business Administration.
Conversely, obtaining equity funding is often difficult for small business owners who are just starting out. You may choose to invest some of your own money into financing your business, or you may receive gifts from family and friends. On a larger scale, equity funding comes primarily from venture capitalists. Venture capitalists generally invest in businesses at their initial start-up phase when they believe that there is a significant likelihood of a strong return on their investment due to the growth of the company or a future public stock offering. While investments from venture capitalists are often seen as a significant achievement for a small business, they can come with hefty requirements or trade-offs, such as an agreement to allow the venture capitalists to have some role in the management decisions of the business.
Sweat equity is one option for a business in need of help but lacking cash. For example, Armando starts a bicycle repair business. He has already spent most of his money on leasing a space and buying equipment with little left over for marketing to find new clients. He makes a deal with his friend Janie to give her stock in his company in exchange for her marketing services. Under this agreement, Janie will earn sweat equity instead of a salary, and Armando will not need to come up with extra cash.