An Introduction to Business Financing

Whether you have several years of operating history under your belt or your small business is still in its infancy, a positive cash flow is vital to the overall health of your operation. Without it, how will you be able to pay employees, launch a marketing campaign or afford your monthly utility bills? Fortunately, business financing is available to meet virtually any need that you may have. From term loans to merchant cash advances to venture capital, you’ve got plenty of options to choose from. But, how do you know which form of business financing is going to be the right fit for your business?

Business financing can feel a bit overwhelming if you don’t know where to begin. This guide is designed to help you along the path. Read on to learn:

• The difference between debt and equity financing
• What forms debt and equity financing take
• How to evaluate which type of business financing is best for you

We’ll get started with exploring debt financing and what it involves.

Debt Financing

Debt financing isn’t all that complicated. When you finance a business with debt, that simply means you’re borrowing money from a lender, which you agree to repay with interest. Some types of debt financing require collateral while others don’t.

Types of Debt Financing: 

Debt financing can take many forms and what works well for one business may not be right for another. Understanding how different types of debt financing operate and what they’re designed to do for your business makes it easier to determine which one best serves your purpose.

1. Term loans

Taking on a term loan means borrowing a set amount of capital, and repaying it over time. The repayment period can be as short as three months or as long as five years, depending on the lender. If you’re interested in something in the middle, Bond Street offers an intermediate term loan, with repayment terms lasting one to three years.

Term loans are a good source of capital when you’re focused on making an investment that will grow your business. For example, Tuft & Needle founders J.T. Marino and Daehee Park used a $500,000 term loan from Bond Street to open their first store. That investment has since paid off and then some—  in the form of more than $100 million in revenue.

In terms of how much you can borrow, loans typically start at $20,000 and top out at $1 million. Interest rates usually run between 6% and 30%, with your rate determined in part by your personal and/or business credit scores. Some lenders will grant term loans to newer businesses with less than a year of operating history while others, like Bond Street, require at least two years in business to qualify.

Best for: Businesses with 9+ months of operating history; businesses that are focused on making long-term investments for growth; businesses that prefer predictable payments

2. Small Business Administration (SBA) loans

The Small Business Administration (SBA) doesn’t offer loans directly; instead, it works with banks to provide loan guarantees on behalf of business owners. That means the SBA promises to pay the bank a percentage of what you borrow if you default on your loan.

SBA loans have quite a few positives, starting with the interest rates. Loan rates are in the 6% to 7% range, which is good if you’re looking at paying 10-15% for a term loan elsewhere. Borrowing limits are also high. The 7(a) loan program, for instance, allows you to borrow up to $5 million dollars and you can stretch out repayment over 10 years.

The biggest downside of SBA loans is how long it takes to get funded. You could apply for a term loan with Bond Street and have the money in a week. By comparison, it could take six to eight weeks or even longer for SBA funding to find its way to your bank account.

Best for: Businesses that need to borrow larger amounts; smaller businesses that are new to borrowing; businesses that need longer repayment terms

3. Equipment financing

As the name suggests, equipment loans are intended for purchasing equipment for your business. Generally, you can borrow up to 100% of the equipment’s value and the equipment itself serves as collateral. Take note, however, that some lenders may expect you to pony up a 20% down payment for the loan.

Some lenders will cap the repayment terms at 10 years while others will extend repayment over the life of the equipment. The interest rates and funding speed are comparable to what you’d pay with a term loan. Most lenders prefer you to have at least one year of operating history so if you’ve got a newer a business, this kind of financing may not be an option.

Best for: Businesses that need to purchase a large piece of equipment; businesses that need more than five years to pay off the loan

4. Inventory financing

When you own a boutique or run a restaurant, keeping your inventory stocked is essential to keeping up with customer demand. Inventory financing allows you to borrow against the value of inventory you plan to purchase. You get the capital you need to fill your shelves and once you sell it, you can repay the lender.

Inventory loans can be funded in a matter of days so if you find a great deal on products or supplies, you can snatch it up quickly. A word of caution on inventory loans, however. Some lenders charge what’s known as a factor rate instead of a regular annual percentage rate (APR).

The factor rate can range from 1% to 5% and on the surface, it looks less expensive than an APR but looks can be deceiving. The higher the factor rate, the more the financing costs and it’s possible to pay an APR equivalent to well over 30%.

Best for: Businesses that operate seasonally; businesses that can afford to repay a loan quickly; businesses that may not qualify for a term loan or other financing

5. Merchant cash advance

Merchant cash advances have something in common with inventory financing in terms of how the fees and interest are calculated. Merchant cash advance lenders also use a factor rate instead of an APR, which may be anywhere from 1.15 to 1.5. The main difference between the two, however, is that a merchant cash advance allows you to borrow against your future credit and debit card receipts instead of inventory.

A merchant cash advance is repaid as a percentage of your daily credit and debit card transactions. This type of funding is good if you need money quickly, you have strong credit and debit sales and you’re worried about a low credit score disqualifying you for a loan.

Best for: Businesses that have a high volume of debit and credit card sales; businesses that have less than perfect credit

6. Business line of credit

With a business loan, the lender gives you a lump sum of money all at once. A business line of credit can be drawn against as needed. If you get a $10,000 line of credit, for example, you could use $5,000 of it buy new computer equipment for your business and still have the remaining $5,000 available in case you need to pay for something else down the line.

One thing to be aware of is that a lender may let you borrow less with a line of credit than they would with a loan. You should also check the line of credit’s terms to see if it has a fixed or variable interest rate. A variable rate can fluctuate over time, potentially increasing your payments if the rate goes up.

Best for: Businesses that need flexible financing; businesses that plan to borrow over the short-term

7. Business credit card

Opening a business credit card is a good way to establish a credit profile for your business. Aside from establishing credit, it can pay for things like your cellphone or utility bills, office supplies, business travel or dinners out with clients. If you pick the right card, you could earn valuable miles, points or cash back on your purchases.

There’s no collateral needed to get a business credit card but your credit score does play a part in the approval process. You’ll also have to sign off on a personal guarantee, which says that you assume personal responsibility for any business debt associated with the card.

Best for: Businesses that don’t need to borrow as much; business owners who want to earn rewards on what they spend

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Equity Financing

Debt financing is typically better suited to established businesses with a regular cash flow that have proven themselves profitable. Equity financing is geared towards newer businesses and startups that lack the operating history or revenue required for a loan.

There’s a catch, however. Equity financing is based on the principle of exchange. An investor gives you the money you need to move into your own office space, develop your product line or cover other startup expenses. In return, they get an ownership stake in your company. You’re not stuck making payments on a loan while you get off the ground but you are giving up a percentage of your future profits (and your decision-making authority).

Types of Equity Financing:

There are two broad categories of equity financing and the one you choose depends on what stage of growth your business is in.

1. Angel investment

Angel investors are individual investors who have jumped through all the entrepreneurial hoops and want to use their success to help other business owners. Angel investors most often work with startups that need their initial seed round to take a business idea and make it tangible.

Besides offering funding, many angel investors will also lend their expertise and act as mentors for fledgling businesses. That’s something you wouldn’t get with a regular loan. As an added incentive, you’re not required to repay angel investors if your business fails. Loans and lines of credit, on the other hand, would still need to be repaid.

Best for: Early-stage startups that need seed funding; businesses that would prefer to work with a smaller pool of investors

2. Venture capital

Venture capital is similar to angel investing but with some slight differences. With venture capital, you may be dealing with a VC firm rather than just one or two investors. The amount of financing available also tends to be higher. Some firms, for example, won’t make investments of less than $1 million.

Venture capital investors also expect equity in return for funding your business. Because there’s usually more money at stake, a VC firm may expect to be hands-on when it comes to making decisions that affect the business. You have to be 100% on-board with sacrificing a certain amount of control when working venture capital financing.

Best for: Startups that need to raise funds beyond the seed stage; businesses that are comfortable with investors taking an active role in decision-making

Choosing a Business Financing Option

Now that you know what debt and equity financing are, the next step is figuring out which form of business financing to pursue. That decision ultimately rests on several factors, including:

• The age of your business
• What you need financing for
• Whether your business is profitable and if so, how much annual revenue it generates
• Your personal credit and business credit scores
• The amount of financing you need
• How you feel about taking on debt vs. sharing ownership of your business

Once you’ve narrowed down your options, you can turn your attention to researching individual business financing options. If you’re interested in a term loan, for instance, compare the APR, fees and funding speed various lenders offer. If you’re pursuing funding from an angel investor, take note of how much equity they’re asking for, as well as any special terms they want to attach to your financing agreement. The more research you do beforehand, the more positive your financing experience is likely to be.