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Overview of Types of Financing
One of the biggest challenges that successful entrepreneurs face is: how to find money so that you can keep growing. For example, if you are a growing retailer you may need additional capital to open new stores or bring on new product lines. For companies who are just getting started, here is a basic overview of the different types of business financing.
Bank loan
What is it? A bank loan is usually the first step for business owners who need additional capital. Bank loans and credit lines are generally the most cost-effective ways to finance a business.
Getting started: Look for a lender who knows your business, industry and financial needs. Independent community banks are often more approachable than the big national banks. The bank will request a business plan that documents why the company needs the loan and how it will repay it.
Line of credit
What is it? A line of credit is a type of loan (often called a revolving line) that allows the borrower to tap into money without having to file a new loan application each time funds are drawn. Credit lines are set for a fixed amount and may be either secured (no collateral) or unsecured (collateralized). They are generally established for one year and are reviewed by the bank on an annual basis.
Getting started: Lenders want to see a documented financial history of a company before issuing a line of credit. Before they grant lines of credit, banks want to see that a company is moving forward financially and has a game plan for the future.
SBA Loans
What are they? U.S. Small Business Administration loans are federally backed loans for small businesses (i.e. the U.S. government guarantees between 70 percent and 90 percent of the loan, making it far less risky for the bank). The loans are normally repaid in equal monthly installments that include both principal and interest.
Getting started: While the SBA sets the guidelines for the loans it guarantees, businesses should go to lenders that offer these loans rather than to the agency itself. Choose the lender carefully- some have specialties. For a list of lenders, check out the SBA web site.
Factoring
What is it? Factoring refers to the process of selling your accounts receivable to a third party lender (or factor) in exchange for cash. Factoring is often used by cash-hungry businesses who have a large portion of their working capital tied up in accounts receivable. Commissions typically range from one percent to ten percent, depending upon the particular service and risk.
Getting started: Go to one of several companies that specialize in factoring. Most traditional commercial banks usually do not offer it; however, they should be able to make referrals.
Private Placements
What is it? A negotiated sale of stocks, bonds or other investments to institutional investors. The buyers are usually a select group of sophisticated investors.
Getting started: Develop an explicit business plan and gather the right team of professionals to help the firm find its way through the financing maze. Certain banks or investment firms that have experience in doing private placements can be good resources.
Venture Capital
What is it? Venture capital is private funding supplied by professional firms who have a knack for ferreting out high-risk but potentially high-reward investments (often associated with technology-related companies). Venture capitalists are not lenders, but instead typically take an equity stake in the business and play an active role in its management.
Getting started: A variety of sources around the country continually seek out promising companies. Many large banks now venture capital divisions. Most venture funds are highly specialized to finance only specific industries and growth stages, so it's important to approach the right firm.
(Hat tip: Cash Flow Blog)
Posted by
at 07:08 AM December 13, 2005
You've missed several financing types which I've used, though they have disadvantages to the ones you've listed:
Home equity line of credit
Business credit cards
Personal credit cards
Loans from friends and family
The biggest disadvantage of all of these is that they're personally secured and put your non-business assets and relationships at risk. They also tend to be more expensive than the other funding sources mentioned, both in up front costs (loan application fees) and ongoing costs (interest rates and annual fees).
But, they have the advantage of being a lot easier to get that other funding sources, particularly for businesses that don't fit the profile the lender is looking for (size of loan, type of business, location, use of loan, use of funds, growth rate, size of business, business history of founder).
As a woman business owner, who isn't buying real estate to house her business, but is running a profitable, rapidly growing service business, the other funding sources have been critical to our success. (I have used traditional funding sources as well.)
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