There are dfferent types of fnancng that an entrepreneur can choose from n order
to fund a new busness. All such optons are categorzed, accordngly, nto two
groups: debt fnancng and equty fnancng, both of whch have benefts and dsadvantages
for the entrepreneur.

When choosng debt fnancng for a new business, entrepreneurs are smply acqurng
a loan from a lendng nsttuton or government agency, such as the Small Busness
Admnstraton. When they decde to choose equty fnancng to fund ther venture,
they are smply exchangng the amount of captal for a pece of ownershp n the
busness. The latter type of fnancng s usually provded by venture capitalists
and angel investors.

Debt fnancng refers to any borrowed money whch the entrepreneur
must pay back to the lendng nsttuton. t can come n the form of a loan, lne
of credt, bond, or even an OU. An nterest rate and other terms apply.

Equty fnancng s money lent n exchange for ownershp n a company.

New businesses
can use equty fnancng for ther startups or when they need to
rase addtonal equty captal to offset exstng debt.

Who depends on ths type of captal?

• Companes whch are well- establshed and have demonstrated steady ,
sold collateral, and proftable growth often rely on debt captal for fnancng
ther busnesses.

• Companes wth a more conventonal approach to management, hgh proftablty,
and/or poor credt ratngs often rely on equty captal for ther fundng needs.

• deal form of captal for small business startups and newly launched companes
snce they have not establshed a sold track record of success and face uncertanty
n ther early stages of development.

Where can obtan ths type of fundng?

• Commercal banks
• Loans through the Small Busness Admnstraton (SBA)

• Personal funds (bootstrap fnances) can be obtaned from savngs, credt
ds, retrement accounts, property equty, etc.
• Frends and fly can lend money for a stake n the company.
•
Angel investors
and venture captalsts can also provde a new busness owner
wth desred captal n exchange for a board seat, a stake n the company, and large
return on nvestment.
• nvestment bankng frms
• nsurance companes
• Large corporatons
• Government-backed Small Busness nvestment Corporatons (SBCs)

Debt-to-equty rato

Hgh (deally, 1:2 or 1:1, depends on ndustry)

Low

Requrements

• Exceptonal credt hstory of borrower.
• Borrowers must show poal lenders they are wllng to nvest money n
the busness by usng ther own money.

• Good-standng credt hstory
• Borrowers must demonstrate ther company s n a hgh-growth ndustry and
there s a poal to produce a large return on nvestment.
• Well-detaled busness plan and ext strategy.

Advantages

• Lender does not gan ownershp; therefore, the entrepreneur s able to mantan
maxmum control over ther busness.

• The borrower has no oblgaton to the lender other than the repayment of
the loan; ther relatonshp ends once the entre amount s pad back.

• The nterest on debt fnancng s tax deductble.

• Dependng on the terms of the loan, repayment of the loan s often a fxed,
monthly .

The busness wll not have all of ts cash flow avalable to do busness

• Allows the entrepreneur to obtan funds wthout ncurrng debt = more cash
flow. Ths wll allow to focus ther aton on makng ther product(s)
proftable rather than payng back the nvestors.
• Enables the nvestor(s) and busness owner(s) the opportunty to develop
a long term relatonshp throughout ther jont busness endeavor.
• The cash flow generated can be used for follow-on nvestments rather than
towards the loan debt.
• Captal borrowed from fly and frends s a quck way to raise capital
wth no overbearng nterest rates.

Dsadvantages

• Requres regular monthly payments wth steadly accrued nterest = lmted
cash flow.

• Tarnshed credt ratngs can result from the nablty to pay back any borrowed
captal, lmtng the s of raising additional capital.

• Often lmted to establshed busnesses wth a sold track record of success.

• Dluton of ownershp can easly occur; the more nvestors nvolved, the
more loss of control.
• Angel nvestors or venture capitalists may feel nclned to have a say n
every busness decson.

• f captal was obtaned from bootstrap fnances, credt ds may be maxed
out. f money was borrowed from fly and frends, then relatonshp strans may
occur.

• Too much equty can suggest that entrepreneurs are not makng use of ther
borrowed funds; whereas too lttle may demonstrate non-commtment on the company
owners’ part.
• Complex reportng s often requred by nvestors.

Applcaton process

• A formal applcaton must be flled out ether n person at the lendng nsttuton
of choce or onlne.

An applcaton and other pertnent materals are requred for angel nvestors and
venture capitalists. Fly and frends usually do not requre an applcaton process.

Credt check

Yes. The hgher the credt score of the company owner(s), the better the
n obtanng a loan.

• Angel nvestors and venture capitalists wll usually conduct a credt check
of the durng the due dlgence process but may rely more on the
poal of return on nvestment.
• Fly and frends usually do not conduct a credt check.

Term optons

• Short-term debt fnancng: total repayment of borrowed captal n less than
one year.
• Long-term: total repayment of borrowed captal n over one year.

Usually, both angel nvestors and venture capitalists are nvolved n an nvestment
for an average of 3-7 years.

Other

• A type of long-term debt fnancng payment s a balloon payment,
whereby the end of the term the lender and borrower negotate a new loan amount
for the resdual amount left.

• Varable rates usually occur wth long-term debt fnancng,
where the nterest rates are adjustable by the lender accordng to market performance.

• Companes can also opt to obtan equty fnancng by sellng company
to employees, Employee Ownershp Plan (ESOP), control
of the company wth them rather than wth outsde nvestors.

Source

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