Types of business finance

All businesses, big or small, need finance at some point. This is true whether they're just starting, looking to expand, purchasing equipment or just smoothing out bumps in cash flow.

In this article, we'll explore the main types of business finance available and the benefits of each.

What types of business finance are there?

There are two main types of business finance: debt finance and equity finance. Broadly speaking, debt financing is funds borrowed from a lender and repaid with interest, while equity financing is capital exchanged for part-ownership or shares in a company.

The two are not mutually exclusive and can be combined to form a variety of financing structures.

Financing options for small business

Running a business can be challenging. Surveys show that 1 in 5 businesses fail in their first twelve months in Australia, while a whopping 60% fail overall.

Lack of capital is one of the main reasons. That could result in insufficient investment in equipment, operations or marketing. However, the main reason is more day-to-day: cash flow management. Cash flow problems are a headache for almost 50% of Australian companies.

This means choosing the right type of finance is critical to the success or failure of your business.

Debt financing

Debt finance is a broad term that encompasses many types of finance options. They share that they do not give away part ownership, but the funds must be paid back with interest.

Loans can be short-term (from 30 days to a year) or long-term (from 1 to 5 years). Long term loans are often for more significant expenses, such as starting a business or for equipment or fixed assets.

There is also usually some sort of credit check. To determine if you're credit-worthy, finance companies may want to look at the following:

Your credit rating

Your business track record and financials

Your past bank history

Whether you've invested your own money

Your ability to repay the loan

Debt financing can be secured or unsecured, with secured loans attached to a fixed asset, such as property. The lender could seize the asset if you didn't meet the payments. Unsecured loans tend to be smaller and attract higher interest rates.

Pros Cons You get to keep control of your business and the decisions that drive it Most types of loan must be repaid in full with interest over a fixed term The interest on the loans is generally tax-deductible Repayments begin straight away You have the option of either long or short loan terms It must often be secured against collateral, which you can lose if you don’t keep up with repayments Funds can be available quickly and when they are needed Constant cash drain from the business, as the loan is repaid every month

Sources of debt financing

The main sources of debt finance include:

Types of Business Finance

Businesses often fail because of a lack of funding for growth in areas of business equipment, operations and marketing. Financing a business is often overwhelming for business owners because there are many options to fund a company, each with different rules. Breaking business finance into three basic categories simplifies the process and organizes the financial needs of the business.

Equity Finance Options

Equity financing is most easily defined as money that buys ownership in the company. As the founder of the company, you may have put $50,000 of your savings into its startup. You may have also received finances from family and friends as silent partners. This is basic equity financing.

Equity financing can be much more complicated, though. Angel investors and venture capitalists might offer seed capital or large funding for a new business. They often take an ownership stake as well as a managerial stake in the company with exit strategies laid out at different periods.

Selling an Equity Stake in a Company

Business owners may opt to sell corporate stock through private or public offerings. Depending on the amount of money being raised by selling shares of stock, regulatory entities may require public disclosures and filings. A public offering makes the company a traded entity on one of the stock exchanges.

Debt Finance Options

Debt financing is borrowing money. There are many types of business loans including unofficial business scenarios where you take an equity loan on your home to finance the business or your father-in-law gives you a loan to start it. There are also small-business loans and equipment or land loans for businesses. Most banks and credit unions offer some type of business financing, many with programs backed by the Small Business Administration standards and programs. There are also commercial lenders who specialize in business loans.

Most business loans are short-term loans, generally with terms from one to five years. Rates are high because of the risk of business failure and are often initiated by a business owner's personal backing of the loan either with savings or property pledges. A property pledge might be a home or other large asset used in obtaining business loans.

Lease Finance Options

Understand Types of Financing – Business Services

So you’ve tapped the bank – including your piggy bank – and you still need funds for your startup? Don’t worry. There are many avenues yet to explore. Consider, with great care and caution, the following sources of financing possibilities.

Angel Investors

These are individuals or groups of individuals, who are willing to personally finance your venture. There is generally a generous selection to choose from, and they are usually less formal in requiring financial paperwork – although a solid agreement is still necessary. They typically are looking for a fast, high return on their investment, and may demand some control over your business. Find an angel investor by asking for referrals from your accountants, attorneys or bankers, or at small business development centers, regional and state economic development agencies, or business schools and colleges.

Business Incubators

Business incubators provide programs designed to help businesses succeed, often including office space, access to equipment, management assistance, and access to financing and technical support.

Credit Cards

These are a good source of fast, low-hassle cash – if you have enough credit. But it can be also one of the costliest. The interest rates can be prohibitive, and on credit card cash advances they are even higher than the standard card rate. Rolling over credit card debt through “zero-interest promotions” is a popular strategy, but if these offers dry up, you could be stuck with a large balance.

Credit Unions

Many credit unions today are branching out to offer basic business services, such as business loans, business checking, credit-card transactions, and other services. They also offer lower interest rates for loans and credit cards. Membership is required, but even these rules have been relaxed lately.

Employees

Offering your employees a small percentage of the company or its profits may be a way to get them to invest in the business. It may also induce them to work harder, since they’ll have more to gain. Just don’t give away the store.

Friends and Family

One of the easiest ways to raise startup money, after self-financing, is to tap those around you: your friends, family, business associates, fellow employees, and so on. One potentially major problem, however, is that they may feel they have some control over your business and want to interfere. It’s important that even casual loan relationships such as these be cast in writing with solid contracts and agreements.

Microloans

Developed by the Small Business Administration (SBA), microloans are designed to provide very small loans – from as little as a few hundred dollars up to $35,000 – to small-business owners and entrepreneurs. The loans, however, are not available directly through the SBA, but through nonprofit community based lenders. Microloans are most often used by startup companies with lower capital requirements and limited credit histories. Interest rates tend to be higher than standard business loans, however. For more information, see Microloans at the SBA Web. Local Micro lenders, include:

Self-Financing

This is perhaps the easiest way to finance your business because there is no one else to answer to. Your resources might include savings and checking accounts, stocks, bonds and other investments, or the equity in your home (through a second mortgage or a home-equity loan, for example). You might even use your IRA or 401(k) plans; but it is important to first discuss this with your accountant, financial consultant or tax preparer. Using your home as collateral for a business loan is the riskiest of all, because if your business fails you could lose your home.

Seller Financing

If you are buying a business from someone who is retiring, or may not need the purchase money in a lump sum, you might consider the seller, or sellers, to finance all or some of the purchase. They’ll make more money over the long run in terms of principal interest. And you’ll have an advisor on standby who wants to protect their own interests.

Small Business Investment Centers (SBIC)

SBICs are privately owned and managed investment funds that use their own capital, plus funds borrowed with an SBA guarantee, to make equity and debt investments in qualifying small businesses. They are, however, licensed and regulated by SBA. And only companies defined by the SBA as “small” are eligible for SBIC financing – that is, when the company’s net worth is $18.0 million or less and its average after-tax net income for the prior two years does not exceed $6.0 million.For more information about SBICs, see Entrepreneurs Seeking Financing at the SBA website.

Venture Capital

Venture Capital Firms are private groups that generally loan money to startup companies with higher than normal growth potential, such as those involved in information technology, biotechnology or medical research. They tend to look for their returns in shares sold during an Initial Public Offering (IPO) of stocks or an outright sale of the company. As such, small businesses are not generally high on their list of prospects, but might be considered in special cases – especially those that match their avenues of return. The National Venture Capital Association website has a Resources for Entrepreneurssection that includes templates of legal documents often used in venture capital transactions.

Crowdfunding

Crowdfunding is a fantastic alternative source of financing for businesses who aren’t able to qualify for traditional financing options, such as bank loans. Crowdfunding is the practice of using the internet to fundraise small increments of money from a large number of people to help start or grow your business.

How does it work?

Visit one of the many crowdfunding websites to see which platform is right for you, noting that they are all different. Some crowdfunding platforms require you to exchange gifts for donations, some are loans, some charge fees and taxes, while others don’t. The City of Philadelphia’s Commerce Department has partnered with the crowdfunding organization Kiva to help Philadelphia businesses crowdfund 0% interest, no fee microloans. To learn more about this platform, visit Once you have selected the platform that works best for you, create a business profile explaining the mission of your organization, who you serve, and the project you are requesting funds for. Different platforms may allow you to post your profile right to the website, while others like Kiva, will review and edit your profile to ensure fundraising readiness. Depending on the platform you use, a combination of your own network and people from around the world will lend/give small increments of money until time runs out, or you reach your goal. For many crowdfunding platforms, if you do not reach your goal, you will not receive your funds. After you receive the funds, you can put them to use! Depending on the terms of the crowdfunding platform you used, you may either be responsible for paying back the funds, or sending gifts to those who contributed to your project.

Kiva City Philadelphia

The City of Philadelphia’s Commerce Department, in conjunction with the crowdfunding non-profit, launched Kiva City Philadelphia to help Philadelphia businesses crowdfund 0% interest, no fee microloans.

Using (or for local information) socially impactful or financially excluded business owners can access 0% interest, no fee microloans for up to $5,000. All of the loans are crowdfunding by hundreds of lenders from around the world, who read about a Philadelphia business owner, lend as little as $5, and become supporters, customers, and ambassadors for the business owner.

Kiva does not check credit scores or collateral when assessing whether a business owner qualifies for a loan, instead they check character. They do this by partnering with organizations around the city, such as The Enterprise Center, New Kensington CDC, Common Ground Management, and The Food Trust, who vouch for businesses they want to support, and by having each borrower access their network for potential lenders.