Factors to Consider When Choosing a Method of Financing a Business

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Unless you have lots of money to start your business, you need to explore financing options. Generally, you can take one of two approaches. You can borrow money from the bank or sell equity in the business in exchange for funds. In weighing these alternatives, focus on several important factors.

Your Need for Control

The level of control you have in operating your business depends on the financing method you choose. When you borrow from the bank, the lender only cares that you make your payments on time. You retain ultimate control over operations. If you take on large investors, though, you normally have to agree to relinquish some level of control. Private investment firms often require that you include one of their representatives on your advisory board. Whether formal or informal, new investors want a voice in how the company grows.

What You Can Afford

Regardless of what you prefer, you sometimes have to get financing in a way that you can afford. If you have little to no personal funds and expect delayed growth in your company, it is difficult to convince a bank to loan you enough money for continued operations. In this scenario, you might have no alternative but to take on equity investment. You don't have to worry about repaying the money. Investors accept the risks of losing their money for the hope of earning substantial profit.

Risk Tolerance

When you choose to retain control and borrow from the bank, you also assume more personal risk in the success or failure of the business. If the company goes under, your personal credit rating and finances will likely take a hit. However, when you take on equity investment, you share the risks with the investors. Essentially, in an equity arrangement, all owners contribute their money knowing the potential for failure exists. If you prefer the more conservative personal approach, equity investment makes sense.

Financial Goals

Closely related to your tolerance for risk is your penchant for wanting significant investment returns. If you borrow from the bank and the business takes off, you reap the rewards yourself. If you take the lower-risk approach with investors, you share in the returns. The expertise and input you receive from those investors may contribute to profit growth, but you divide your personal returns among the shareholders who took on risks with you.

References

About the Author

Neil Kokemuller has been an active business, finance and education writer and content media website developer since 2007. He has been a college marketing professor since 2004. Kokemuller has additional professional experience in marketing, retail and small business. He holds a Master of Business Administration from Iowa State University.

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