What is funding (financing)?
The process of providing funds for business activities, purchases, or investments is known as financing. Thus, Banks, for example, are in the business of supplying capital to businesses, consumers, and investors to assist them in achieving their goals.
However, financing is essential in any economic system because it allows businesses to purchase items out of their immediate reach.
Types of Financing
- Equity Funding
Equity funding is a method of raising funds through the sale of inventory. Companies raise money for a variety of reasons, including an urgent need to pay bills or a long-term goal that usually requires funds to invest in their expansion. Hence, a company effectively sells ownership of its company in exchange for cash when it sells shares.
- Debt Financing
Moreover, debt financing occurs when a business sells debt instruments to individuals or institutional investors in order to raise funds for working capital or capital expenditures. Individuals or institutions become creditors in exchange for lending money and receive a guarantee that the debt will be repaid in full, including the principal and interest.
Sources of Equity Financing
- Self-Funding
Self-funding is frequently the first step in obtaining funding. It necessitates the use of personal funds as well as revenue generated by your business. Before they agree to lend you money, investors and lenders will expect you to self-fund.
- Friends or Family
Offering a partnership or a share of your company to family or friends in exchange for equity is a common way to raise funds. However, carefully consider this option to ensure that it will not have an adverse effect on your relationship.
- Investors from the private sector
Investors can put money into your company in exchange for a portion of the profits and ownership. Furthermore, they can also help you with advice and expertise.
- Venture Capitalists
These are commonly large corporations that make significant investments in new businesses. Therefore, businesses must have high growth and profit potential. Venture capitalists typically necessitate a large controlling stake in your company and frequently provide management or industry expertise
- Government
In general, the government does not provide funding to help you start or buy a business. However, you might be eligible for a grant for the following reasons:
- Development and research
- Expansion of business
- Innovation
- Exporting
Advantages of Equity Financing
- Freedom of debt
Unlike debt finance, you do not have to pay back the amount on investments. Thus, having no debt, especially for small businesses that are just getting started, can be extremely beneficial.
- Business relationships and experience
In addition to capital, investors frequently bring essential skills, managerial or technical skills, relationships or networks, and credibility to the table.
- Follow up funding
As a corporation develops and thrives, investors are frequently eager to contribute additional cash.
Sources of debt financing
- Financial institutions
Moreover, credit unions, banks, and building societies offer a variety of short- and long-term financing options. Some of those options are as follows.
- Loans for small businesses
- A credit line
- services for overdrafts
- Leases of equipment
- Asset-based lending
- Retailers
Many stores offer store credit through a finance company if you need money to buy furniture, technology, or equipment. This is typically a higher-interest option. It is best for companies that can pay off the loan quickly during the interest-free period.
- Suppliers
The majority of suppliers provide trade credit. This enables your company to postpone payment for goods. The terms of trade credit vary. Thus, you might be able to get it if your company has a good relationship with the supplier.
- Factor Companies
You can get funding for your business by selling your company’s outstanding invoices to factoring companies. The debtors are then pursued by the factoring company. Hence, this is a quick way to get cash, but it can be costly when compared to other options.
Advantages of Debt Financing
- Debt financing can help a small business save a lot of cash
In order to take your business off the ground, you frequently rely on high-interest debt such as credit cards, cash advances, and lines of credit. This type of debt reduces cash flow and can make day-to-day operations more difficult. The ability to pay off high-cost debt and reduce monthly payments by hundreds or even thousands of dollars is a significant benefit of debt financing.
- Debt can help a company grow
Long-term debt can be used to purchase inventory or equipment, hire new employees, or expand marketing. Taking out a low-interest, long-term loan can provide your business with the working capital it needs to run smoothly and profitably all year.
- Deductions from taxes
Tax deductions are a significant benefit of debt financing. The basic interest payment on that debt can be deducted from your business income taxes because it is classified as a business expense.
- No need of selling your company
One of the foremost advantages of debt financing is that you do not have to give up your rights or ownership of your company. When you take a loan from any financial institution or an alternative lender, you are only responsible for making timely payments for the duration of the loan. If you give up equity in the form of stock in exchange for funding, on the other hand, you may be dissatisfied with outside advice on the future of your company.
Debt financing Vs. Equity Financing
The primary distinction between debt and equity financing is that equity financing provides additional working capital without requiring repayment. However, you should repay the debt financing, but your company is not required to give up any equity to get funding for your business. The majority of businesses use a mix of debt and equity financing.
Depending on the type of funding that is more easily accessible, the state of their cash flow, and the importance of maintaining ownership control, companies choose debt or equity financing, or both. Thus, the D/E ratio indicates how much of a company’s funding comes from debt rather than equity.
However, the creditors will view a relatively low D/E ratio favorably which benefits the company if it needs to access additional debt financing in the future.
