Money. You need it to run your business. In fact, successful businesses can fail if they don’t have enough capital to get to the next level, which is one of the reasons why a huge number of businesses fail in the first 1 to 5 years. In fact, I know of a company right now that is struggling to find financing to import products into the US. It has great products, fantastic distribution channels, and a sound business plan; unfortunately the financing options available in the originating South American country keep it from creating enough product to make the venture worthwhile.
There really are only two types of financing available: debt financing and equity financing.
Debt financing
Debt financing is loan-based financing: this is where you mortgage your home or take out a loan from the bank or get a business loan from a lending institution or write promissory notes to your family to get money. In each case you pay back the money you owe plus interest. The lender earns a profit for the financial risk they took and that profit comes to them in the form of interest payments.
While you’ll not likely use bonds for your size of business, a bond is an excellent example of debt financing.
Lenders like this type of financing because the money is regular and predictable. Businesses like this type of financing because the payments are budgeted, constant, and anticipated. The risk is that you won’t be able to meet your payment obligations on time.
Equity financing
Equity financing is where someone owns a part of the company and earns money not from regular payments but from the growth of the value of the company. This is done through shares in the company. So if a company is divided up into 100 shares and you sell 40 of those shares for $10 each, you’ll get $400 in capital and the buyer (or buyers) will own 40% of the company. If the company increases in value and someone offers the shareholders more money for their shares (for example, $100 per share) then they’ll have made a profit.
The typical stocks on the New York Stock Exchange are the perfect example of this kind of financing, but many small corporations issue shares to private investors.
Dividends are periodic payouts on equity financing, which are another incentive for an investor to offer equity financing over debt financing. Dividends are not “mandatory” (unlike debt payments) but they are helpful in keeping shareholders happy.
Investors like this type of investing if they see a huge and profitable future for the company. Businesses like this type of investing because there is no ongoing obligation to pay back the shares, as there is with bonds. There is a risk, though, and that is in diluting your business with the sale of too many shares so that someone could swoop in and buy up a majority interest in the company without you realizing it.
So when you’re looking to grow and you’re hunting down financing options, remember that there are only two kinds and potential investors will typically offer one or the other or a hybrid combination of the two.
