As you plan and set goals for your small business in 2023, one area to look at is financing. Will you need additional funding at some point in the New Year? If the answer is yes, how will you raise the money? Take a closer look at the two primary means of raising capital — equity financing and debt financing — and what you need to know about each.
In equity financing, you give up a piece of your business (equity) in return for an investment of capital. Equity investors may be private investors, venture capital companies, or even your friends and family.
Angel investors are the most realistic source of investment capital for most small business owners. Angels are private investors; some invest individually, while others form angel groups to pool their money. Generally, angels are experienced business people, former business owners, or professionals. In addition to the capital they can provide, they can also offer much-needed business guidance and expertise.
If your small business has strong growth potential in an industry such as technology or healthcare, you may be able to get venture capital. Venture capital firms tend to focus on businesses with a track record of success and the potential for rapid growth with a high return on investment. They make large investments, but in return, they will want to have a strong say in your business and possibly even take over management.
If you plan to seek capital from investors, it’s important to make sure the business structure you chose will allow what you want to do. For example, if you operate as a sole proprietor, you won’t be able to take on equity investors, since there is no separate “company” to invest in.
A General Partnership, C Corporation, or Limited Liability Company (LLC) all enable you to sell shares in your business. However, if you have an S Corporation, the number of shareholders you can have is limited to 100, which could be a problem. In addition, the S Corporation form limits what type of person or entity can be a shareholder or owner, which could cause problems either in raising capital or transferring ownership of shares down the line.
While taking on investors may seem like an easy solution to getting the money you need, you should think carefully before giving away equity in your business. Depending on the amount of equity they control, investors can make it more difficult for you to make decisions about your business without their input. Your relationships with investors, even those you are currently close to, may change in the future, leading to unforeseen difficulties. If you give up too large a stake in your business, you may eventually lose control of it altogether.
As the name implies, debt financing means taking on debt that you need to repay at some point. Typically, this means a bank loan. However, debt financing can also take the form of loans from friends and family, credit unions, alternative financing sources, or even taking credit card advances.
Business loans can be secured or unsecured. Secured loans require you to put up some collateral, such as business equipment or your house, to obtain the loan. Unsecured loans don’t require collateral but are often more difficult to get and have higher interest rates and fees.
If you’re seeking a bank loan, the best place to start is with a bank that makes Small Business Administration (SBA) loans. SBA loans are partly guaranteed by the SBA, which makes banks more willing to lend to small businesses they otherwise might consider risky borrowers.
Other sources of debt financing include:
- Equipment financing – If you are purchasing business equipment, the company that makes the equipment may have financing options available.
- Invoice financing – Invoice financing companies advance you money based on the number of your outstanding invoices.
- Factoring companies – Similar to invoice financing, factors purchase your outstanding invoices for a percentage of their value and then take over collecting the unpaid invoices for you.
- Merchant cash advances – If your business makes most of its sales via credit cards, such as an e-commerce business or retail business, you may be able to get a merchant advance based on the number of your average credit sales.
Make the Right Choice
To make sure you’ve selected the right form of business for your financing needs, it’s best to discuss it with your attorney and accountant before making any decisions. If you need to make changes to your business structure before seeking financing, start now so you’ll be ready to go after the capital you want in 2023.