The difference between debt and equity financing
There are two main types of financing for a business, debt or equity financing. Debt financing tends to be the type of financing you receive from a traditional bank loan and equity financing tends to be the financing you receive from venture capital in your business from outside investors. The benefit of debt financing is that it is finite and will pay off debt over time to a zero-sum balance with no additional obligation to the lender. The downside of debt financing is that traditional lenders will take a hard look at your business, including how long it has been in existence, operating income, expenses, and require tangible assets as collateral for the loan. Also, lenders will likely want you (and any other directors of the organization) to personally guarantee loan repayments. Another disadvantage of debt financing is that your organization will have to pay some other type of regular payment (usually a monthly payment) under the terms and conditions of the financing and this can suck up critical cash flow, especially with small businesses.
The benefit of equity or venture capital financing is that you will receive money in exchange for equity in your business in the form of stock or some other form of capital as a percentage of revenue or gross/net sales. A primary benefit of this type of financing is that there is typically no monthly payment requirement for investors. Instead, you are giving up your ownership interest, more often than not, permanently.
Traditional lenders, like banks, will view your business very differently than venture capitalists. Bankers want a zero or near-zero risk position when providing financing and will rely almost entirely on the operating economics of the business without regard to “potential future growth.” They want to see strong cash flow backed by tangible assets before making a deal—the ingredients most small businesses lack or they wouldn’t be looking for financing, right? The venture capitalist, on the other hand, tends to look at the management team and the potential future growth of the business more than the actual operating numbers, especially for small businesses with great potential but few sales and little or no operating history. Although these two types of lenders vary in their approach to scrutinizing a business for financing, you can be sure that careful scrutiny will be carried out on your business…
In addition to actual operating economics and pro forma analysis, both types of lenders will take a close look at two particular documents: 1. Your business plan. 2. Your bank or loan application package. These documents, if put together correctly, can make the difference between success and failure when dealing with any type of lender.
There are plenty of free SBA-related materials out there that tell you how to create standard, top-tier business plans, but they tend to be written for the perfect business and not the average Joe who isn’t perfect. If you are looking for some type of financing for your business, I suggest you visit our site and check out our business e-books. We have several that cover a variety of topics and there are two specifically that will be a real treasure for you. One is called Power Planning (a powerful report on writing a wide variety of business plans) and How To Raise Money For Your Business (teaches you how to put together professional loan application packages). They are priced at $5 each and can be worth millions in the hands of the right person. I am not trying to promote the product, I am simply warning you.
The secrets to obtain financing from any type of lender is a closely guarded secret by financial and commercial brokers for several reasons. The main one is that it forces people like you to do business with them and they earn commissions. The SBA materials, while good, in most cases don’t have the street smarts to get the job done. The proof is in the pudding: what has the SBA done for you? The SBA is just another government-backed bureaucratic nightmare for most. We also have some links for venture capital firms in our business links area located on our site on the Smart Link Zone page; Everything is free.
Give it some thought… Your future may depend on it.
For your success! Copyright © 2006 James W. Hart, IV All rights reserved
