Most small businesses need cash infusions at some point, and how you secure the funding can make all the difference between whether your business succeeds or struggles. To help determine which is best for your business, let’s break down the three primary types of funding available: debt, equity and hybrid financing.
Debt: Borrowing to grow
Debt financing involves borrowing money and repaying it with interest over time. This includes traditional options like bank loans, lines of credit, and Small Business Administration (SBA) loans.
The main benefit of these options is that you retain full ownership of your business, though loan payments can put a strain on cash flow. Also, lenders often require collateral—like equipment, real estate or other assets. If payments are missed, creditors can seize the collateral and, in some cases, pursue legal action against the business or owners.
This option works best for businesses that have stable revenue and are able to make timely payments. And since you retain ownership, you preserve control over decision-making. However, if your cash flow can’t sustain the regular loan payments, debt financing is not a workable option.
Equity: Trading ownership for capital
Equity financing means selling a portion of your business to investors in exchange for capital. Common sources of equity funding include:
- Angel investors
- Venture capital firms
- Crowdfunding platforms
Unlike debt financing, equity financing doesn’t require repayment, but it does mean giving up some ownership and potentially sharing future profits.
This option is often best for start-ups or high-growth businesses that may not qualify for traditional loans due to limited profitability or lack of a solid credit history. While equity investors can offer valuable guidance, expertise, and networking opportunities, it’s important to consider the trade-offs like shared decision-making and less control over the direction of your business.
Hybrid financing: Combining debt and equity
Hybrid financing combines elements of both debt and equity financing. Examples include convertible notes, where debt is converted into equity under certain conditions, and revenue-based financing, where repayments are based on a percentage of future revenue. These options offer more flexibility by aligning payment terms with your business’s performance.
Hybrid financing is a good choice for business owners looking for tailored funding solutions. It allows you to leverage the benefits of debt and equity, but the terms can be complex and require careful negotiation to ensure they fit the needs of your business.
Financial statements matter
Accurate financial statements are essential when seeking funding for your business. Lenders and investors will want to see a detailed and comprehensive financial package that includes:
- Income statements, which show revenue, costs, and profits
- Balance sheets, which summarize your assets and liabilities
- Statements of cash flows, which detail how money flows in and out of your business
Additionally, you might be asked to provide supporting reports like accounts receivable aging, detailed expense breakdowns, and information about owners and key employees. These documents provide a clear picture of your business’s financial health and operations, so potential funders can evaluate the risks and potential rewards of their investment.
Most lenders and investors will expect to see at least two to three years of historical financial data, along with projections for the next two to three years. These reports should tell a clear, compelling story about your business’s financial stability and growth potential.
What’s right for your business?
Choosing the right way to fund your business comes down to your business model, growth stage, goals, and how much risk you’re willing to tolerate. As your business’s needs evolve, you might end up using a combination of debt, equity and hybrid financing.
Your Smolin advisor can help you keep your financial records in check and walk you through the pros and cons of each option. Reach out and let’s talk about how to fund the next phase of your business’s growth.