Which Type of Business Funding is Best?
Starting a business is often an important life achievement for some people. This often shows that a person has reached the pinnacle of their employment for others and are ready to set off on their own. In traveling this path, potential entrepreneurs face many perils along the way. A common danger faced by most entrepreneurs is how to fund their potential business. A quick Google search of “which type of business funding is best for a small business?” results in 8,000,000,000 and a ½ (slight exaggeration) different views as to which type of funding is best for a small business owner. Seemingly, this is a whole bunch of choices and one must wonder why one of the hardest things to do when starting a business is to raise capital.
As a professional business plan writer in Orlando, FL., and a small business owner, I found that business funding is often a personal decision that is best left to a well-informed business owner. From this, allow me to take a few moments to enlighten everyone to some of the benefits and challenges of various types of funding sources.
Equity Funding for your Small Business
Equity funding is by far the most popular funding for small businesses. Equity funding is simply when an investor (this includes the owner) gives money to an organization. In return, the investor receives a percentage ownership of the company. For example, as a business owner taps into their 401(k) to fund startup costs for a business, they are in return, often awarded 100% ownership of the company. In contrast, his cousin Joe gives us the funds to start organization, in return, he may ask for a certain percentage ownership of the company. This is to be expected when dealing with equity funding.
A benefit to this scenario is that the business owner does not have to pay the received funds back to the investor. However, a challenge to the scenario is that now we have to answer to cousin Joe for major decisions in the company. Further, profits received from the business they also need to be shared based on ownership as well.
Debt Funding for your Small Business
The second popular method of funding a small business during startup is through debt funding. All this means is that a person is taking out a loan, whether it is through a bank or on a credit card, and the funds are expected to be paid back in full and with interest. Popular lenders for small businesses include friends and family, banks and financial lending institutions.
A benefit from using debt financing is that a business is able to make money on borrowed funds. This often significantly increases return on equity when the endeavor is successful. A challenge to this type of financing is in relations to monthly or quarterly principal and interest payments. As previously stated, when borrowing money, the funds are expected to be paid back. Because the payments are required, this often puts strain on monthly profits until the loan is paid off.
Grants for your Small Business
A final, less known, source of funding for a small business is through grants. A grant is simply when a person, government agency or company gives money to any small business and does not expect funds to be repaid nor do they receive an ownership stake in the company. Now this may seem like one of the best ways to get funding. However, this type of funding option is not all peaches and cream.
The benefit for this type of funding is that the money does not need to be paid back. Once a company receives a grant, so long as they stay within the requirements of the grant, are free to use the funds however they so choose. A challenge for this type of lending option is that grants are often very competitive. For example, FedEx offers a yearly grant to the small business. However, the also receive thousands of participants seeking the grants and only a handful of the applicants will be awarded funds.
In summary, funding a small business often seems like a monumental decision. However, it really just breaks down to whether a business owner wants to make monthly payments and retain ownership of the company. If this is the case, then debt financing is the way to go. Conversely, if the business owner does not mind giving up ownership rights to the company, then forgoing monthly payments may be a great way to start up and equity financing may be your ticket. Regardless, every business that is him and started will need to make the decision as to whether to use debt or equity. Make sure to weigh the pros and cons before making this choice.
Thanks for reading Quality Business Plan's blog. What are your thoughts about start up business funding? Please share your thoughts and experiences in our comment section.
Author: Paul Borosky, Doctoral Candidate, MBA.