- There are various different external financing options, but all come with pros and cons
- A company's chance of securing funding increases if the business is profitable
- New businesses or those who with a credit history which leaves them unable to get traditional financing options can consider alternative financing options
Summary
Key Takeaways
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Every business needs financing. You may want to expand your business or start a “war chest” for an acquisition, start a business start-up or scale one up. But how do you get it? In today’s increasingly deregulated environment, business financing options abound. This article explains the options available, from internal financing to the different types of external financing.
Internal financing
Internal financing is the process by which your company uses its own profits – such as those from your turnover or the sale of stock, services or assets – as a source of capital for a new investment rather than soliciting outside sources.
On the plus side, it’s quicker and cheaper than getting funds from third parties, and you keep control and ownership of your company.
On the negative side, using your own money limits your company's flexibility, so it is not ideal for long-term projects.
If you need a big cash injection for new ideas, products or businesses, or have limited internal funds, various types of external financing could provide better business financing options.
Types of external financing
The variety of lenders on the market today, coupled with advancements in technology, make it easier to apply for a business loan – whether for small business financing options or corporate financing options.
Banks
Even though banks are no longer the only source of business financing, they are still a dominant player in business lending and various types of debt financing.
If you have a good relationship with your bank, a traditional bank loan and credit facilities may be good solutions.
A loan is money secured (against your company’s assets) or unsecured (in which case your trading history is important, and you may need a co-signer), repayable in a set period, with interest rates either fixed or flexible. It can be short-term (two-three years) or long-term (over three years).
A line of credit is a revolving credit facility that enables you to withdraw money, fund your business, repay it, and then withdraw it again when you need it. This is a convenient, quick way to access cash, but the interest rate is usually higher than a bank loan and therefore is best limited to short-term use.
- Pros: possibility of low interest rates for bank loans (depending on your credit score); you don’t give up control of your business.
- Cons: the long, time-consuming process of getting bank financing.
Angel investors
If you don’t mind giving up some equity in your business to a wealthy individual (or group of individuals) who are willing to take a chance on your business, this could be a good option.
- Pros: Angel investors will have business experience and can offer valuable guidance.
- Cons: There’s no free lunch. You're likely to have to give up some control of your business.
Venture capitalists
If your business has high growth potential and you’re okay with giving up an even bigger chunk of your business in return for greater investments, this is a way to secure funding and mentoring. Venture capitalists are usually happy to help your business grow quickly to realise a good return on their investment in a short period of time.
- Pros: In addition to providing funding and expertise, venture capitalists can open doors to other contacts in their network.
- Cons: Because of the significant amount of funding venture capitalists provide, you could lose control over a large part of your business.
Business credit cards
This can be a good small business financing option, a way to charge expenses and pay them off later.
- Pros: There are plenty of credit cards for financing businesses that can pay you a bonus in the form of points, miles, or cash-back.
- Cons: Temptation. Taking a cash advance from a credit card is tempting when you need money fast, but the fees and interest rates can make it an expensive financing option.
Alternative business financing options
If you have a new business with an operating and/or credit history that won’t allow you to qualify for other types of financing, these alternative business financing options are something to consider.
Factor financing
Sometimes called “factoring”, this is a funding source that sells your receivables to a third party (a “factoring company”) who agrees to pay your company the value of an invoice less a discount for commission and fees. It can help improve your short-term cash needs. The factoring company is more concerned with the creditworthiness of the company you’ve invoiced than that of your own company.
Purchase order financing
This short-term commercial finance option provides money up-front for verified purchase orders. The loan terms can usually be adjusted if order volume drops. It’s a good solution for growing businesses with little capital or poor cash flow that want to take on large orders, especially for manufacturing or import-export businesses.
Turnover loans
This is a cash advance based on your business’s future revenues. Because interest rates are likely to be high, it should be limited to very short-term financing.
Revenue financing
Sometimes known as royalty-based financing, it pledges a percentage of your future ongoing revenues in exchange for a regular share of your business’s income until the predetermined loan amount has been paid (typically, between three to five times the original investment).
It is different from various types of debt financing, in particular because interest is not paid on an outstanding balance and the lender does not receive direct ownership in your business.
Equipment financing
This is a loan used to purchase business-related big-ticket items, such as a restaurant oven, vehicle, or major office equipment. It works like a car loan, requiring periodic payments that include interest and principal over a fixed term. The lender may require a lien on the equipment as collateral.
Structured debt
Various types of debt financing are popular corporate financing options for larger businesses. Chief among these is structured debt, a type of debt financing that provides substantial amounts of capital for such things as covering a management buy-out or refinancing existing debt.
This type of debt financing helps to create efficient cash flow while making savings on repayments. It’s also a useful business financing option for mid-market businesses, as it increases working capital and protects reserves.
Key points to remember about business financing options
Whether you opt for small business financing options, corporate business financing options or even types of debt financing, you’re often taking on a sum of money provided by a lender which you, the borrower, must pay back (usually plus interest) over a set period of time. Some lenders may even charge a penalty if you decide to pay off your loan amount early.
Here are some additional key points to be mindful of:
- Carefully analyse the KPIs to share with your banker or investors to pursue your business financing options.
- Your chances of funding increase if your company is profitable, if you have been in business for more than two years, and if the loan you are asking for is less than 25% of your annual turnover. Calculate your company's debt ratio to understand how a loan will affect your finances.
- Don’t overlook the advantages of trade credit insurance to help you obtain financing. By insuring your receivables against non-payment, your cash flow is secured and protected, which can prompt lenders to look favourably on your financing requests. Trade credit insurance provides your lender with assurance, while ensuring your business has sound financial backing.
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