Business Financing: What It Is & How to Get Financing
9 min. read
Aug 1, 2022
There is at least one, undebatable truth when it comes to a business. Regardless of size or industry, you need money to keep a business running. Working capital is the fuel that drives the most crucial parts–labor, supplies, equipment, etc.–of any business operation. Without working capital, your business will never have what it needs to function, let alone grow.
Even a successful business doesn’t always have the cash on hand to pay for everything they need when they need it. This is where financing–small business or otherwise–comes into the picture. Financing provides a funding avenue when your business doesn’t have the needed working capital to either make a large purchase, address a temporary financial upset or whatever issue might provide cause for a lack of necessary funds.
Understanding and obtaining financing can be a complicated process… and it often is. We’ve put together this guide to provide a comprehensive knowledge base for those seeking financing. Within it, we define exactly what financing is, explore the different types of financing, dig deep into the specifics of small business financing, and finally, explore the best financing options currently out there.
Let’s begin by defining just what financing is.
What is business financing?
In the life of most companies, there will come a time when they are faced with a purchase need or a financial setback that they can’t cover with the cash they currently have on hand. Financing for a business is simply borrowing money from an outside source so you can pay for short-term obligations when needed. There are a handful of different business financing options, which we’ll explore in greater detail below).he most common are either borrowing from a financial institution–a bank, a credit provider, etc.–or bringing in outside investors to share whatever might be your current financial burden.
Financing for a business makes large inventory purchases, covering labor costs, addressing unexpected financial upsets and so much more, less stressful by eliminating the need for upfront working capital. By borrowing from a credible financial source, your business will be able to smartly spend outside its current means while maintaining and growing a healthy business in mind.
There’s a handful of business financing options though and we’ll walk you through those next.
Different types of financing
The concept of financing for a business is simple, but when you start digging a little deeper, it becomes quickly apparent that there are more than a few business financing options available. To create some clarity on what type of financing your specific business might need, we’ll explore two of the main types of financing.
If you have a mortgage or you’re paying off your car loan, you’re already well aware of what debt financing is. Debt financing simply implies that you’re borrowing working capital from a financial institution like a bank. When it comes to financing a business, it works exactly the same way.
To start debt financing for business, you only need to visit a financial institution–in person or online–and fill out an application. If your business is already established, the bank (or whatever financial institution you’ve decided on) will make sure your credit is up to snuff. If you are trying to acquire business acquisition financing (i.e. attempting to get money to start a new business) then your potential source of credit will look into your personal financial background to ensure that you’ll be able to pay back the amount borrowed.
Larger businesses, businesses that have been in operation for longer periods of time and businesses with more layers built into their corporate structures, will have to deal with more complicated applications when applying for financing. Any credible financial institution will want and need to do a thorough accounting of your business’s financial history.
Debt financing can be a great option when you’re looking to finance a business. By borrowing money from a lending institution you aren’t forfeiting any control of your business like you might do if you’re borrowing money from investors or even family. Also, any working capital you end up borrowing is tax deductible and any payments you do make will be scheduled out far in advance, so you’ll be able to better see and control your cash flow.
On the other hand debt financing does have disadvantages. Financing a business is just another way of adding more to your recurring monthly payment (for the time being). And this means you’ll have to have the necessary cash flow when the time for repayment arrives. If not, you will face fines and the possibility of damage to your credit score.
Equity financing is a simple concept: your business needs money and, to get it, you enlist investors to “back” your business. Meaning you borrow money from investors to help get your business off the ground. This is a common option for startup business financing where a company seeking business acquisition financing engages with what are often referred to as venture capitalists or, more dramatically, angel investors. Both terms refer to those with money who want to invest in an up-and-coming business with the hopes that the business will grow quickly; ultimately this would allow the investors to not only make their money back but make more money on their investment.
When you are financing a business using equity financing, you are–for better or worse–giving over partial ownership to your investors. This provides an advantage in case your business fails, as financing for business acquired through equity doesn’t have to be paid back. Rather, the investors who provide working capital for business financing succeed–or fail–right along with the businesses they invest in. If you receive equity financing and your business ends up going bankrupt, the investors lose out on the money they’ve invested.
Similarly, because the investors are partial owners of the business, there won’t be any monthly payments. The fewer recurring payments your business has to deal with, the more cash you’ll be able to keep on hand and apply to whatever financial needs you might have.
On the flip side, equity financing means those providing financing for a business are owners of this business. This means that you’ll have a partner–or many partners–with opinions and demands and ways they believe the business should be run. Any decisions you make going forward will need to be agreed upon by your investors. Beyond this, investors now own a percentage of your business, meaning any money you make going forward, your investors will own a percentage of that amount.
Whether you plan on using debt financing or equity financing (or some other form of financing altogether) there’s a lot to consider. For those seeking small business financing, there are even more things to consider. We’ll look at small business financing in our next section.
Small business financing
If you are owning and operating a small business, financing is extremely important from start to finish. As mentioned above, small business financing is often used in the beginning of a company’s life cycle to get them started and then is repeatedly leaned upon during major growth periods. Most small businesses only have 27 days worth of cash on hand at any given time and financing for a business provides a lifeline for them to continue to operate, let alone succeed.
Small businesses are often forced to reach above and beyond their cash reserves to make payments on everything from inventory to payroll to whatever financial turmoil they’re currently struggling through. Depending on what kind of small business you might be running, there is a bevy of options to choose from.
Term business loans
A form of debt financing, term business loans provide a chunk of cash up front that you then pay off in installments. Your payment terms will be dependent on a handful of variables–credit history, how much you’ve borrowed in the past, etc. Term business loans are provided by banks or online lenders with online loans being the most convenient but typically being saddled with the highest interest rates.
Secured/unsecured business loans
Secured business loans are simply loans that have some form of collateral attached to them. This could be a house or a vehicle or anything else that has confirmed value. If you are unable to pay back the loan, this collateral will act as a second form of payment and will be taken by whoever is your lender.
Unsecured business loans are, conversely, loans that aren’t attached to any collateral. These are much harder forms of small business financing to be given and are usually only a business financing option for established–even successful–companies.
Small Business Administration (SBA) Loans
The SBA is a government organization that doesn’t actually give loans for small business financing, but rather provides guaranteed payback to financial institutions that do provide small business loans. If you are looking for an SBA loan, they are provided by approved SBA lenders. SBA loans are intended for business acquisition financing, startup business financing, and companies that are looking to grow from a small business or just in need of financing for supplies, necessary equipment or property. These loans feature extremely low interest rates but are very difficult to qualify for.
Now that you know just what financing for a business looks like, the business financing options that exist, and how they apply to small businesses in particular, let’s look at a few of the best financing options for a business.
6 best financing options for a business
1. Traditional bank loans
These are the loans most individuals are best acquainted with. This is financing or a business that originates from a bank. Traditional bank loans typically come with low-interest rates, but because of this can be exceedingly challenging for small businesses to be awarded.
2. Online loans
Online loans are simply debt equity without the hassle of going to a financial institution in person. Instead, you’ll fill out a loan application online (and go through the assorted security and credit questions that come with it) and then be lent the requested amount of working capital. This working capital can be used on anything you need for your business. It’s a convenient, often exceedingly lenient form of financing for a business, but can be burdened with high interest rates.
3. Business lines of credit
A business line of credit is similar to a credit card, in the fact that it’s a line of financing for a business that can be drawn upon up to a credit limit. It’s great for small business financing because it is a standing source of working capital that can be spent when and if you need cash in hand. These are provided by both standing financial institutions and online lenders on an as-needed basis.
4. Business credit cards
Business credit cards are an excellent business financing option for burgeoning small businesses. They offer standing financial flexibility and because they are typically easy to apply and qualify for, if diligently managed, they offer new business owners a handy way to build business credit. That said, credit cards are known for high interest rates, especially for business credit cards. Plan for this going in though, and a business credit card is a functional, convenient way to access business financing.
5. Small business grants
Grants are basically free money granted to businesses who apply and qualify for them. If you receive a small business grant (from the many, many organizations that offer them) you are, for all intents and purposes, being given money that never needs to be repaid. Because of this, the competition for small business grants is tough and plentiful. Applications will have to be dutifully filled out with thought and care and even then the odds of your business being given the grant are pretty low.
Crowdfunding, bluntly defined, is simply asking people for money. This can be your friends and family. This can be a select group of people. This can be an outright ask of the public. Crowdfunding is usually accomplished through a variety of companies, including but not limited to:
As you can see financing a business has a lot to it. We hope this guide has shown you not only what financing for a business is but also some of the many business financing options available to businesses just like yours.
You can get access to instant short term financing and working capital tools when you use the Plastiq platform.
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