Advantages & Disadvantages of Different Sources of Finance

One of the ongoing challenges of operating a business is maintaining a steady flow of finance to pay for new projects and fund growth. Securing finance is also extremely important during the startup process, as a company without enough money to operate until it can establish a revenue stream won't last long.

Business finance typically comes from one of three types of sources. The first is internal sources, which include savings or money from the sale of assets. The second is ownership capital, which refers to offering stock to investors who pay cash for their shares and take an ownership stake in the company. Finally, finance can come from nonownership capital, which refers to grants, loans, lines of credit and investment from venture capitalists, who don't take an ownership role in the business.

Some sources of finance offer special benefits. Selling stock is among the fastest ways to get access to a large amount of cash, and it's money you'll never need to pay back directly. Internal sources of finance keep control within the company and don't subject you to interest payments on loans. Finally, nonownership capital is a vote of confidence from the investor or agency that issues a loan or grant. Grants are especially valuable because they don't require repayment, and might be available on a recurring basis.

Each source of finance also has its own limitations. Ownership capital makes you responsible to a group of shareholders who have partial ownership rights. Loans cost interest, which the lender will demand back on schedule whether you've turned a profit or not. Internal sources are limited and once you sell off your assets or spend your savings, you'll need to turn to a new source of external finance anyway.

The amount of money your business needs, along with how soon you need it and how long you expect to need before you can pay it back, will impact which sources of finance work best. For example, a bank loan comes with a fixed repayment schedule, but you'll need to begin making payments relatively soon. Ownership capital gives your company a sudden influx of cash, but you can only take advantage of it once before you need to give up even more control by selling your own shares. If you need a long-term investment that might not show returns any time soon, selling assets or dipping into savings are likely better alternatives.

The methods you use to secure finance for your business can directly affect how your business grows and operates. If you choose to have an initial public offering, or IPO, by selling stock, you'll distribute control of your business to shareholders who will be able to vote for board members and have a say in the company's direction. Selling assets usually involves giving up a portion of your security or production capacity, which may involve a larger restructuring plan.