43% of small businesses applied for a loan in 2022, while 29% of small businesses end up failing due to running out of capital, Fundera reveals. Most businesses end up needing financing at some point – even larger companies regularly need capital injections to cover current pressing needs. And, for small businesses, it’s all the more important to select the right financing strategy.
Making the wrong move may leave you stuck with a growth-inhibiting repayment plan for years to come or even result in you losing all or part of your business. By taking the time to research different financing options, you can be sure to choose the right one for your business and facilitate long-term business growth. Read this guide to financing your business to have the best strategy this year.
Equity Financing
Equity financing involves selling shares of your business – usually to venture capitalists or angel investors – in return for cash investment. In most cases, venture capitalists are firms such as Intel Capital, Kleiner Perkins, or Accel. These firms work with partners, investment advisors, accountants, and lawyers to assess the viability of potential investments. Since venture capital firms typically handle large investments (usually worth over $3 million), these deals are often lengthy and complex. Angel investors, on the other hand, are typically individuals who want to take a smaller stake in a business – they value speed and simplicity.
Equity financing is particularly attractive as you never have to pay the investment back. Venture capitalists or angel investors aren’t creditors or lenders – rather, they’re partial owners of your business. And so, if you go bust, all investment money will naturally be lost. Equity financiers also appreciate business success doesn’t happen overnight. They’ll provide investment without pressuring you for fast results. Also, since you’re not burdened with regular repayments, you can expect to have liquid cash on hand for operating expenses.
That said, equity financing does come with a huge potential downside – namely, you’re no longer sole owner of your business. Venture capitalists and angel investors are active investors; you’ll need to run any decisions you make by them beforehand. Keep in mind, the larger the risk of the investment, the greater the stake investors will want in your business – if an investor owns over 50%, you’ll no longer be the boss.
Business Loans
While there’s a wide variety of business loans available, most generally fall into the category of either secured or unsecured. Secured loans require collateral – assets offered to guarantee the loan. So, this typically means your business must provide property as a guarantee. Since secured loans are therefore guaranteed, they let you borrow over a longer timeframe and are also easier to be approved for. Unsecured loans, on the other hand, don’t involve collateral – although they may instead come with higher interest rates.
When choosing between a secured or unsecured loan, it’s important to consider whether or not you’re in the position to pay the interest rate and/or put up collateral.
Secured loans can be a particularly good option for new businesses lacking a credit history since, as they’re less risky for lenders, you have a higher chance of being approved. In contrast, an unsecured loan may be a smart option if you either don’t have collateral or don’t want to put any up.
Keep in mind, however, unsecured loans are more rigid in terms of requirements and may also demand a personal guarantee (this typically means you agree to be personally responsible for repaying the loan and will use personal assets if needed).
You usually also need to have been in business for a set amount of time and reached certain profit requirements to qualify for an unsecured loan. So, if you’re a new business, a secured loan may be the only option currently open to you – and that’s okay.
As your business expands over time, you can work towards qualifying for an unsecured loan. Ultimately, whichever route you go down, be sure to do your research first; take time to compare different loans and lenders, along with their terms and conditions, to find the best option for you and your financial situation.
Mezzanine Capital
Mezzanine capital is a type of finance that blends elements of both equity and debt financing. Usually, mezzanine capital is an ideal solution when a business can’t get a large enough loan and doesn’t want to lose shares via equity financing.
Although it comes with higher risk for businesses, it allows you to borrow a greater amount and has the potential to offer greater returns – usually within 10%-20% per year. Think of mezzanine capital as a business loan, which, if you’re unable to repay, essentially becomes an equity share. Equity, therefore, functions as security, and the lender gets a share of the profits.
Mezzanine finance can be a vital lifeline for younger companies. Banks aren’t always willing to finance new businesses as around three years of credit history is usually needed. Mezzanine capital, on the other hand, can be a way to generate the extra finance required – it’s usually easier to get as they give the bank a bigger safety net.
Mezzanine capital is also a fairly flexible option – it can be customized to suit the unique needs and financial situation of your business. For instance, if you’re unable to make the next interest payment, it can be delayed, and the interest instead rolled up into the loan balance as needed.
And what about the downsides? Although interest rates vary, they’re usually higher with mezzanine capital as the business is considered higher risk by the lender. Terms may also include specific security requirements and restrictions relating to financing and operating your business that you must adhere to.
And, since outstanding loans are converted to an equity share, there’s also the risk of the lender becoming a partial owner of your business.
Choosing the right financing strategy is essential for long-term business success. Equity financing, secured or unsecured loans, and mezzanine capital are just some of the most beneficial options available to your business.
