You can fund your business operations and investment one of four ways:
- debt (a loan from the bank or another third party),
- equity (your own funds),
- an equity partner (taking on an investor) or
- internal funds (profits).
Each of these options comes with its own set of risks and advantages, and it can sometimes be difficult to figure out the best option, or whether you should look for financing at all.
Consequently, finance can be an extremely difficult and frustrating for business owners and, as such, needs to be planned for and executed as carefully and thoroughly as possible.
Let’s consider the four types of financing, to help you determine which is right for you.
- Debt
Risks
- You may not be able to generate sufficient cash flow from your business operations to service the debt.
- You may be unable to repay the principle at the end of the loan period.
- The level of security required for you to finance may leave your personal assets vulnerable if you cannot meet repayments.
- You will need to pay interest on top of the sum borrowed, making the financing more expensive.
- You may be vulnerable to changes in interest rates.
- If you are in the early stages of business, it can be difficult to get external finance.
Advantages
- You retain control over your business by not having to answer to partners or investors.
- The profit and growth of the business is all yours as you would not have to share it with partners.
- Fixed repayments are agreed to from day one and you can better manage your cash flow.
- Lower cost of capital (interest payable) and raising debt finance (bank fees, insurance fees, legal/accounting fees).
- Interest and associated costs are tax deductible.
- Personal equity
Risks
- Putting your own money on the line means you bear the risk of the business and its ability to achieve the growth you require.
- While it does not impose any significant cash flow requirements, it could take longer to generate the level of funding required.
- You might lose your capital if the business doesn’t survive.
- No tax deductions are available as there are no servicing costs.
- It can place strain on family relationships should personal financial obligations (such as meeting mortgage payments) be put under stress.
Advantages
- You can raise funds without exposing your personal assets to risk.
- You have no exposure to interest rates.
- Less burden as there are no monthly loan repayments, improving cash flow.
- An improved financial profile with lenders and/or investors.
- If you have prior credit issues, accessing debt could be a problem, whereas personal equity will bypass this hurdle.
- An equity partner
Risks
- You might lose control if they seek to acquire a share of your business.
- If you sell a share of the business, this could trigger a capital gains tax event.
- Potential conflict with the investor.
- Greater pressure from the investor to achieve growth and higher returns.
- Need to establish an exit strategy.
Advantages
- You could benefit from mentoring support from the investor.
- Easier access to funds with less compliance requirements than banks.
- No exposure to interest rates.
- External resources could add strategic input and alliances.
- A more stable financial structure.
- Profit
Risks
- Funds used from the business may impact negatively on business operations.
- Reduced funds for working capital.
- Inability to cover unforeseen costs.
Advantages
- Increased profitability as there are no direct costs imposed on you and your business.
- You have no exposure to interest rates.
- You retain control over the business.
- The growth of the business is all yours.
- Your assets are not vulnerable to creditors.
When it comes to choosing which financing option is right for you, there are a number of factors to consider.
If you are fortunate enough to have a profitable business and have maintained your cash reserves, using these funds can be one of the most favourable alternatives.
However, while the ideal scenario would be for all operations and investment to be funded by your profits, this may not always be possible due to cash flow requirements. Your ability to generate increased cash flow through good management of your working capital is very important. You need to be able to generate excess cash from your business operations to ensure this funding option is best suited to your circumstances. For this reason, you’ll need to look at all possible alternate sources of funding to ensure you adopt the one most suitable to you and your business.
Are you in need of finance or funding to help grow your business? Do you clearly understand the cost of money? Contact us for a free 30 min strategy consultation. Click here to get started.
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