Published on April 29th, 2014 | by Pete1
Choosing the Right Source of Business Finance for Your Business
If you’re an entrepreneur looking to fund a new startup or the owner of an SME seeking additional financing for future growth, how do you go about choosing the best source of finance for your particular business needs? Let’s look at how to make the best evaluation, as well as some of the different financing options available.
Broadly speaking, business owners should ask themselves the following questions in order to determine the best source of finance for their enterprise:
1/ How much money do I need? The amount required will determine the source to some extent. For example, long-term bank loans may not provide enough flexibility to make them suitable for a small amount of borrowing. On the other hand, some sources won’t provide enough cash if your business requirements are larger.
2/ How soon do I need it? If you need the money like yesterday in order to settle essential bills or other trading debts, it’s likely that you’re not going to find the cheapest deal in town. However, if you’re looking for a loan for future growth – for example, to invest in new equipment or bigger premises – then you should take sufficient time to seek out a suitable source with the best available terms.
3/ How much will it cost me? Every business owner wants to find the cheapest financing option available that matches their borrowing requirements. Finance costs usually mean the additional money you need to pay back on top of the initial amount loaned, most typically in the form of interest. However, businesses can also use trading profits to attract funding and equity financing may be suitable for businesses that would prefer to give up a stake rather than have a large debt to repay.
4/ What’s the risk? Any financial source you seek funding from will measure how likely your business is to yield a profit for them. At the very least, lenders will want to make sure you’re not going to cost them money. The more risky your business appears to them, the higher will be the lending costs transferred to you. Many sources may also seek personally-backed guarantees from borrowers, meaning that a business owner’s personal assets –including their house or car – may be at risk of repossession to repay any debt if the business fails.
5/ How long do I need it for? Generally speaking, long-term financing can be acquired on better repayment terms than short-term funding so it’s important to evaluate the type of project you require money for in order to secure the best deal.
Long-term finance is more suitable for any investment that is unlikely to yield profits in the immediate future. For example, large projects such as capital investment or a plan to enter new markets will likely require long-term finance. Because the dividends are less immediate and carry greater risk, long-term financing usually requires some form of security or collateral guarantee. Mortgages and hire purchase are two well-known examples of secured long-term finance. Other examples include bank loans, retained profits, debentures and share issuance.
Short-term finance is more suitable for covering day-to-day business operations, such as meeting payments for salaries, rent or suppliers during a cashflow shortfall. Because the repayment terms are shorter, there is less risk involved for lenders who, as a result, are more willing to lend without extensive security. Some typical examples of short-term finance include bank overdrafts and credit card borrowing, as well as credit provided by suppliers.
Internal and External Financing
Another point to consider is whether you should seek financing for your business from internal or external sources. External financing derives from sources that have no direct trade with the business and would include bank overdrafts or loans or the issuing of new shares. Alternative lending sources including equity financing, peer-to-peer lending or merchant cash advances are also examples of external finance.
In contrast, internal finance is money that can be generated from the trading of the business itself. This might include money from sales, credit extended by suppliers, selling off surplus assets or reducing business inventory. Because internal finance generally doesn’t involve interest repayments – although trade suppliers extending credit may request some interest or at least favourable terms for doing so – it’s likely to be a less costly form of financing. However, using internal financing is unlikely to generate the larger sums required for long-term projects so it’s more suitable when financial requirements are smaller.
Understanding your business’ own unique borrowing requirements will help you determine the best source of finance for your business.