3 common sources of finance for small businesses

Open up your business to different funding options.

When it comes to your professional career, the dream is to do what you love and make money while doing it. It's possible when you're a business owner. Whether it's baking bread or providing in-home health services, the options and opportunities are limitless when you're working for yourself.

But to make money as a small-business owner, you need the funding to hire staff and purchase equipment, materials, office supplies and various other odds and ends that your specialty requires.

If you don't have the requisite cash on hand, there are several options you can pursue: debt, equity and internal. While hardly exhaustive, closely reviewing these three choices – including the advantages and disadvantages of each – can help you make the best decision for how to go about launching, improving or expanding your company to the next level:

1. Debt-based financing

The most common funding source of them all, debt-based financing is when you obtain a loan from a third party, such as a bank, credit union or financial institution. The underwriting process is fairly straightforward. The lender reviews your financial details, such as your credit history, available funds and employment status to figure out how much you're eligible to borrow and at what interest rate. The loan then gets paid back in instalments over a predetermined period of time, which is typically several years.

Positives of debt-based financing

  • Interest may be tax-deductible: While the interest that accumulates means you'll wind up paying more in return than you're borrowing, much of this can be offset, given that it's something you can deduct from tax liability.
  • You retain control: Unlike other lending arrangements, in which the lender may own a certain percentage of your business, debt-based financing enables you to reap the full benefits that come with owning a company, such as decision-making authority and valuation.

Negatives of debt-based financing

  • Security is usually mandatory: A security means something of value that you must put up as a condition of the loan. Whether in the form of residential property, land or something else of value, securities must be surrendered to the lender if you fail to pay the borrowed amount back.
  • Must report to lender on financial status: Your lender will want to see evidence of your profitability, which requires you to provide regular updates regarding your revenue. This can be time-consuming, tedious and potentially stressful.

2. Equity-based financing

Similar to its debt-based counterpart, equity-based financing provides you with an immediate infusion of funding from an investor of some kind – an entrepreneur, developer, magnate, venture-capital fund or any other entity that has capital. But instead of you paying the debt back in full, the investor recoups their investment by owning a certain portion or percentage of your company, meaning an equity stake. This means that whatever money you earn as a business owner, some of it will go toward the investor in perpetuity (or as long as you own the company).

Positives of equity-based financing

  • No security necessary: While there may be exceptions, traditionally this form of funding does not require a security on your part, which enables you to make better use of your available assets that can be put toward raising funds.
  • Can leverage investors' knowledge or connections: Whoever invests in your company likely has significant levels of experience and may be able to provide you with tips or business opportunities that wouldn't be available to you otherwise.

Negatives of equity-based financing

  • Must share the proceeds: Depending on the arrangement, an equity-based loan means the investor gets to keep some of the profit that your business generates, the percentage of which is determined at the bargaining table, or whenever the loan transaction occurs.
  • Potential for conflict of interest: Owning a portion of the company may also means the investor gets to make some of the decisions about how the company operates on a day-to-day basis. These choices may run contrary to yours, which could potentially create conflicts that can be difficult to address or manage over time.

3. Personal savings-based financing

With this financing method, whatever money that you have saved up goes toward building your business. Given that you're the ultimate source, no security is necessary and you retain 100% decision-making authority as to how much money you put toward the company's creation, expansion or improvement.

Positives of personal savings-based financing

  • Ease and simplicity: Since you're the funding source, there aren't any hoops to jump through with regard to applications, credit checks or reporting requirements.
  • No interest or servicing fees: You don't need to worry about repayment or changing interest rates.

Negatives of personal savings-based financing

  • Can't build credit: Since you're not borrowing, you can't solidify your creditworthiness by repaying the loan amount.
  • Reduces cash flow: The money you commit will take away from what funds you may have used for operating expense or other needs.

From maintaining the books to determining the best funding source, WMC Accounting is in the business of helping your business succeed. Please contact us today to see how we can help you grow.

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