Finance: How-To Understand Finance and Financing Options for a Small Business

• Through the issuance and/or sale of debt 
• Through the issuance and/or sale of equity. 
• Through asset-based lending.

In other words, you can borrow money, find investors, or use assets to get the money you need to finance your business.

Get A Loan (Create Debt).  Borrowing money is a natural, time-honored tradition for financing (most larger companies have some kind of debt throughout the life of their business).  

A loan of cash takes place when a creditor agrees to lend you money in exchange for repayment, with accumulated interest, at a future date.  You can obtain "loans" from card credits and banks, secure a trade credit (from a supplier), obtain a line of credit from a bank or other financial institution, or borrow from friends and family.

Generally, institutional lending sources are more interested in businesses that are at least two years old and have already established profitability.  Some banks or lending institutions may allow you to put up collateral, such as the equity in your home, against a business loan for a new company, but the majority will require that the business itself, not other assets, is able to support the debt it incurs.  Businesses may also consider Small Business Administration (SBA) guaranteed loans as a possible source of capital.

Personal loans, otherwise known as "friend and family financing," are loans secured from someone you know personally.  Generally these loans range from several hundred to several thousand dollars.  (As long as these loans are not asset-backed, they fall under the category of debt financing.)
 

There are a variety of types of investors depending on how much money you're looking for, what stage of development you're in, how much control you're willing to give up, and what potential investors are willing to pay for a piece of your dream.

Equity investors take many shapes and include:  

• Angels.  An Angel can be an investor known to routinely provide seed capital to younger companies or a wealthy personal acquaintance who is willing to underwrite phase one of your dream (start-up).

• Venture Capitalists. These can be a sole individual or a venture capital "firm" raising funds from wealthy individuals and institutional investors (such as funds) who seek to allocate a portion of their holdings into potentially very-high return investments.  Generally venture capitalists look to invest in companies that have already achieved some success and need a lot of money to go 

  "Yes, we were happy enough, but I wish dear Karl could have spent some time acquiring capital instead of merely writing about it." - Karl Marx's widow, reflecting back on her marriage.

  to the next level, have the potential for explosive growth and will soon be in a position to go public.  Be warned that many VCs often put in their own management teams to run your business their way.

• Small Business Investment Companies (SBICs) affiliated with the Small Business Administration channel private investors' money, sometimes combined with some government money or guarantees, to small, fast-growing businesses that have already proven themselves.  Currently there are over 270 SBICs nationwide with $3.5 billion in private funds and $1 billion in government money to lend.

• Private Placements are when you sell shares in your corporation - not on the open public market - but to select individuals.  This type of equity offering is best for companies that have established themselves as a worthy investment but don't have the resources or desire to take their company public.  With a private placement, a business is able to retain a degree of control: you can decide how much of your company to sell, for what price, to how many investors, and even to which investors.

• IPOs (Initial Public Offerings) occur when you sell shares of your company to the general public in the form of stock.  This can open you up to intense scrutiny from the Securities and Exchange Commission (SEC), state regulators, and the finance community.  Once you are publicly traded, your finances and internal operations become public knowledge, as you are required to file reports to your shareholders and to securities regulators.  An IPO is the first time a company sells its shares to the public.  Although public offerings are a good way to raise tens of millions, the process requires business owners to give up a large measure of control.

Types of asset-based financing include: 

• Convertible Debt:  a loan that can convert to equity in your company under certain circumstances.  This generally refers to when you throw the option of equity in your business

  Most states do not count a wedding ring as an asset in a bankruptcy claim.  This means that creditors cannot seize the ring, no matter what the debt may be.

   into a debt situation to sweeten the deal with a potential lender.  
  

• Factoring: selling your accounts receivable to a third party (the factor) for a discounted price.  By selling your invoices, you can generate cash sooner than if you waited to collect the money on your own.  After paying you a discounted amount, the factor takes title to your invoices and then collects them when they are due. Commercial finance companies, some banks, and other financial companies generally purchase receivables.  

• Equipment Financing:  leasing equipment, rather than buying it.  This kind of financing is available from banks, finance companies, and from equipment manufacturers and retailers.  

• Financing From Customers & Suppliers:  loans and/or equity investments from the people who buy your goods and services or sell you theirs.  These contacts can usually be approached to invest when you provide something that is unique or hard to find elsewhere, or because you've become a crucial link in their distribution network.  

• Strategic Partnerships: forming an alliance with another company whose business development goals are congruent with yours. This can offer benefits beyond a transfer of cash.  For example, if you are developing a revolutionary new telecommunications device, it makes sense to go to a company like AT&T for financing.