Every business needs capital at some point in time to grow. The absolute majority of enterprises will need it even before the launch of the company. There are four main types of business financing.
1. Own funds
Everything is simple here. If until the moment the company pays off, you have enough money that you have on your personal deposit in the bank, then you use it without attracting third-party capital and thereby avoiding additional risks and costs, and in the future you will reinvest part of the profit back into the business.
2. Bank loan
A bank loan is a so-called debt financing. Private business lending is not much different from consumer lending, but, like a car loan, it is targeted and may include a number of special conditions for the entrepreneur. However, quite often small companies and self-employed are limited to consumer credit.
Cons
The disadvantages of debt financing are obvious: the debt must be repaid and repaid with interest. You can’t just take it like that and declare yourself bankrupt, because this has many negative consequences. In addition, getting a sufficient loan amount is not easy.
Pros
The most important advantage is that the bank has no control over your company and is not involved in decision making, as it does not own any stake in your business. Monthly payments are easy to calculate and add to the list of mandatory expenses. Once you repay the loan, your relationship with the lender ends there.
3. Venture capital
Venture capital is the so-called equity financing. It involves the funds of investors, which they are willing to risk to invest in your business in order to make a profit in the future.
Unlike loans, you do not risk getting bogged down in debt if your business fails, as you will not owe the investor anything in this case.
However, the investor does not just give you money with the expectation of a part of future income. He becomes a co-owner of your company, and the size of his share of the business will depend on your agreement with him and the amount of his investment. The higher the risk and the amount of investment, the greater the stake the investor will want.
It should be noted that if an investor owns more than 50% of your company, then basically all important decisions will be made by him. In addition, the distribution of profits is also correlated with the shares in the company.
Of course, there can be several investors, and all of them will have their share in the business and claim the profit according to the amount of their investment. When a company goes public and enters the stock market (IPO), then it can start issuing shares. In this case, all investors who bought the issued assets become shareholders of your company. But this is a separate and large topic.
Types of investors
There are two main types of investors who can potentially inject capital into your business: venture capital firms and business angels.
Venture capital companies have a whole staff of employees, so they are very careful about their investments. Usually they are approached in the hope of getting more serious amounts.
Business angels are individuals with personal capital, which they are ready to direct to the development of interesting and promising, from their point of view, business models. Business angels are much easier and faster to work with, which is why they are often sought after by startups.
Cons
The main disadvantage is that you lose complete control over your business. If you strive to be personally responsible for all decisions, then other co-owners of the company can become some anchor for you, because their opinion will also have to be taken into account, and it will not always coincide with yours.
In addition, even if your investor will not participate in any way in the development of the business, he still claims a percentage of the profits for the entire time of owning a part of the company, unless you buy it from him.
Pros
Of course, the absence of the risk of being in debt in case of failure can be called the main advantage, because investors are co-owners, not creditors. In addition, there is no need to worry about monthly fees to the bank, but instead reinvest all profits back into the business or to buy back investor’s shares.
Another plus is that venture capitalists usually have a lot of experience in developing companies, which can be decisive for your business, because they are interested in its success just as much as you are.
4. Mezzanine financing
Mezzanine capital is a cross between direct investment and a bank loan. It may even be the best solution for many companies. The only problem is that the mezzanine financing is often given only to established companies that have shown good results in a certain time period.
Unlike a classic loan, a mezzanine investor relies on the calculation of the fundamental value of the borrower’s business, and not on the ability to repay the loan on time. At the same time, obtaining a mezzanine financing is much faster than attracting investors to capital.
Mezzanine financing entitles the lender to convert the loan into equity in the company if you do not repay the debt on time or in full. Compared to a bank loan, this is a longer financing instrument with more flexible repayment and interest payment terms.
In case of bankruptcy, payments to creditors participating in mezzanine financing are made after payments on other, higher priority types of loans (bank loans), but before payments to shareholders.
This type of lending can be used for many purposes, such as mergers and acquisitions of other competing companies, and it can be provided in many forms, including securities.
Cons
A mezzanine loan has a higher interest rate than a bank loan.
Pros
The speed and ease of obtaining funds can be relevant for many entrepreneurs. A loan can be provided not for a specific project, but for the enterprise as a whole, which allows for flexible distribution of financial flows. During the first few years, the borrower pays only the interest on the loan.