How to choose the right financial model for your business

For many entrepreneurs, starting your own small business begins with an idea.

For many entrepreneurs, starting your own small business begins with an idea. Whether that's a product or service, you've identified a hole in the Australian marketplace and have a plan to fix it. But the transition from whiteboarding an idea to a small business that is profitable, employs workers, and pays taxes requires a huge amount of work.

Beyond the name and products of your company, the biggest decision you'll need to make is what kind of financial model is best for your goals. While bringing in an accounting firm to help you create a business development plan is always a good idea, here is an overview of the various options you have, along with their benefits and drawbacks.

Debt finance

There are two main ways to source funds when you're starting your own small business in Australia: debt finance and equity finance.

Debt finance refers to taking out a loan that will need to be repaid. Traditionally, you'd work with a bank, building society, or credit union. You may apply for a business loan, a line of credit, overdraft services, invoice financing, equipment leasing, and asset financing.

There are, however, other options for your lending needs. For example, the purchase of physical items you'll need to get started – think office furniture or computers – you may be able to get them through store credit with the retailer. It's worth noting that these tend to be fairly high interest, so it would be a good option if you can repay the loan before any interest-free period you have expires.

Similarly, suppliers of goods may provide an option to delay payment. Finance companies may also offer finance products, though it's important that you check that they have registered on the Australian Securities and Investment Commissions website to ensure you're dealing with a company that is above board.

A final option that may be worth exploring is to ask your friends and family for money. Depending on the financial state of the people in your community, they may have the money to support your new small business and are eager to do so. Remember to make sure any agreement you have even with close friends and relatives should be formal and include a plan to pay them back. Discuss the time frame they expect to see their money again and whether they'll charge you interest. Even the strongest business plans are not a guaranteed success, so consider how the arrangement could affect your relationships before you start making phone calls to your family.

Pros and cons of debt finance

There's a reason taking out business loans is a popular way to kick start a new small business: It gives you the opportunity to maintain control over your small business, as opposed to bringing in partners or shareholders who will have their own goals and opinions. And while you'll be beholden to repay the debt to the bank, business, or family member, the profits from your business are yours to reinvest or keep as you see fit, and any debt you repay will be tax deductible.

The main drawback to debt finance is in its name: You're starting your business in debt. Ideally, this won't be a problem and you can allocate the payments into your budget and repay them comfortably. However, if you have difficulties getting your business off the ground and are unable to keep up with your payments, you could face bankruptcy. Most debts also incur interest, so you'll ultimately have to pay back more than you borrowed.

Equity finance

An alternative to beginning your small business by taking out loans is to finance via equity. You are allowing people or corporations to purchase a piece of your business by buying in at the ground floor. This money doesn't need to be returned, which is appealing to many small-business owners.

There is a wider pool to choose from when financing through equity. If you have the money to start a small business, that's a great place to start – you'll not be in debt, nor will you have to share your profits with anyone. However, this isn't realistic for most Australians.

Start by courting investors and lenders who believe that you have a viable small-business plan. This could include private investors and venture capitalists. The former is frequently an individual looking to invest and grow their wealth. Frequently, these investors may come with their own business expertise or contacts that can help you get off the ground. Venture capitalists are usually large corporations who invest huge amounts of money in various start-up businesses that they view has having the potential to be profitable.

You can also look into an Initial Public Offering – an IPO – where you publicly offer shares of your business to raise capital.

Pros and cons of equity finance

A major benefit of using equity to start your small business is that you'll start debt free. No need to worry about interest rates or repaying loans. If the business doesn't take off for whatever reason, you won't be on the hook, financially speaking.

However, every person or company you bring onboard will reduce the profits you take home and the amount of influence you have over your own business. You'll be beholden to your newfound shareholders who are entitled to being a part of your business decisions. In particular, venture capitalists frequently purchase large shares of businesses and have a major influence on the direction they go. Depending on your view, this could be a company stepping in and providing much-needed assistance for getting your business off the ground, or you can see it as a company taking control of your pet project.

While starting a small business is no small feat, there are many resources available for you to help finance your project. Consider what your goals are and what is most important to you. If you want to maintain complete control over the first months and years of your business, perhaps the relative risks of debt equity are worth it. If taking out a loan is unappealing, equity finance could be a better option.

Starting your small business on a smart financial path is the best way to grow and thrive.

For more information on setting your business up for success, contact WMC Accounting today.

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