Sources of business finance for your small business

When building your business plan, one of the most important areas you’ll need to cover is your finances. This includes a funding plan, which outlines how your business will use investment to achieve its goals.

But how do you get those funds in the first place?

Well, the good news is that there are many ways to get the money you need – from traditional routes like bank loans and credit lines to newer options like crowdfunding and joint ventures.

In this article, we’ll take a closer look at the different ways businesses can fund themselves, to help you decide which option is best for you. We’ll also break down the pros and cons to help you make informed decisions and secure the right resources your business needs to grow.

What is business finance?

Business finance refers to the process of acquiring, managing and using funds to achieve a company’s goals. 

It involves everything from securing funding (e.g. from loans, investments or equity) to budgeting, forecasting and ensuring the business has enough cash flow to cover expenses and invest in growth opportunities. Whether you’re starting a business or looking to expand, it’s all about making the right decisions to keep yourself financially healthy.

Why is business finance useful?

Very few businesses have the resources to fund their plans independently. Raising business finance allows you to generate significant amounts of capital, which can be invested in different aspects of your business, such as expanding your operations, hiring more people, improving your products or boosting your marketing efforts.

Types of business finance

There are two main types of business finance – equity and debt. Each has its own advantages and disadvantages, and choosing the right one depends on your business’s needs, goals and financial situation.

Equity finance

Equity finance involves raising capital by selling shares in a business to investors. The investors then become partial owners of your company and share in its profits or losses.

One of the biggest perks of this is that you don’t have to repay the money, which helps cash flow and reduces the financial pressure. Since investors become part-owners, they share in both the risks and rewards, and they often bring valuable expertise and connections to help your business grow.

However, it’s important to know that by selling equity, you give up some control over your business, as investors will have a say in decisions. You’ll also need to share profits with them, which means you get less of the earnings, and the more equity you sell, the smaller your ownership becomes. The process of finding investors and negotiating terms can be time-consuming as well, and there’s often pressure for fast growth to meet their expectations.

Debt finance

Debt finance is when you borrow money to fund your business, typically through loans or issuing bonds, with the agreement to pay it back over time and usually with interest. 

Unlike equity financing, you don’t give up any ownership, so all earnings from your business remain yours. You remain the sole decision maker, which can be crucial if you want to maintain your company’s vision and mission. Debt finance typically comes with a fixed repayment schedule, so you know exactly when and how much you need to repay, which makes it easier to plan financially. What’s more, interest payments are often tax-deductible, which can help lower your tax burden.

On the other hand, the biggest challenge is the pressure of repayment – whether your business is doing well or not, you still have to meet your loan obligations, which can put a strain on your cash flow. Additionally, the cost of borrowing isn’t limited to just the principal amount; interest rates add extra costs, increasing the overall price of the loan. If you fail to make payments, you risk defaulting, which can lead to legal consequences of losing your assets.

Short term business finance sources

These kinds of business finance sources are designed to provide quick cash flow for businesses that need funds for a short time. Some examples of short term sources include:

1. Bank Overdrafts

A bank overdraft allows your business to withdraw more money than is in your account, essentially giving you access to extra cash when you need it. You can use it to cover temporary cash flow gaps, like having more expenses than expected but haven’t received payments from customers yet.

Overdrafts are usually flexible, meaning you can use and repay them as needed, but interest is charged on the amount you borrow. Some banks also charge additional fees for using an overdraft, and if you regularly exceed your limit, the bank can reduce or remove the facility completely.

2. Trade credit

This option allows your business to purchase goods or services from suppliers and pay for them later, typically within 30, 60 or 90 days. This arrangement is a good way to ease cash flow pressure, especially for small businesses. The long time limit also gives businesses time to generate revenue from those goods before having to settle the bill.

However, late payments can lead to penalties, such as higher prices, interest or even legal action. Some suppliers may also stop doing business with you if your payment history isn’t reliable.

3. Short term loans

A short term business loan is designed to be paid in a relatively short time, usually within 6-12 months. These loans are ideal for businesses facing urgent needs, such as covering unexpected expenses or something that needs to be acted on quickly, like stocking up on inventory during busy periods. You can apply for them through banks, alternative lenders or online platforms.

The amount you borrow depends on your business’s financial health and repayment capacity. The main downside is that they come with higher interest rates than long term loans. Repayment terms can be rigid as well, and you may have to meet strict eligibility requirements to secure the loan in the first place.

4. Merchant Cash Advancements (MCAs)

This is a lump sum loan that is given based on your business’s future credit card sales. The lender provides the money upfront, which you then repay by allowing them to take a percentage of your card transaction sales until the loan is repaid. This can be ideal if you have fluctuating sales and need cash quickly.

While the flexibility is a major perk, MCAs come with high interest and fees, which can make them expensive over time. So if your sales slow down, it could extend the repayment period, and you might end up paying more than you initially borrowed.

5. Peer-to-peer lending

Peer-to-peer lending (P2P) allows businesses to connect directly with individual investors through online platforms like LendingClub or Funding Circle. These platforms allow businesses to borrow funds without going through traditional banks, often with more flexible terms. Businesses can get short term loans at competitive rates, especially if they have a good credit history.

That being said, the application process may take longer than other options, and fees may apply for using the platform. Moreover, if you can’t keep up with repayments, you may not get the same protection as you would from borrowing from a traditional lender, meaning there’s a higher possibility of legal action being taken.

6. Business credit cards

Much like a personal credit card, business credit cards offer a quick and easy way to access short term finance. You can use them to pay for expenses like supplies, inventory or travel costs. The main advantage is that you get a revolving line of credit, and you can carry a balance from month to month.

Still, interest rates can be high, and if you don’t pay off the balance in full each month, you could end up with a significant amount of debt. Credit cards are a good option for managing small, day-to-day expenses, but over-relying on them can quickly become expensive in the long run.

7. Invoice financing

Invoice financing, otherwise known as “factoring” involves businesses getting cash upfront by selling their unpaid invoices to a lender. The lender will typically give you around 80-90% of the invoice value upfront, and once your customers pay the invoices, the remaining amount (minus the fee) is given to you.

This is a good option if you have long payment cycles or struggle with cash flow due to slow-paying customers. However, factoring fees can be quite high, and you’ll need to be comfortable with the lender taking control of collecting payments from your clients.

Long term business finance sources

These kinds of finance sources are useful in providing stability and support for major projects, acquisitions or asset purchases. Here are some of the most common long term finance sources:

1. Bank loans

Bank loans are a traditional and widely used financing option where businesses borrow a fixed sum of money and agree to repay it over a predetermined period, usually around 3-10 years or more. These loans often come with fixed or variable interest rates, allowing businesses to pay repayments based on their financial circumstances.

While they offer predictable repayments and no loss of ownership, securing approval can be a lengthy and difficult process, as it requires detailed financial records, strong credit history and sometimes collateral, such as property or equipment, to back the loan. Meeting those requirements can be difficult for a small business, and the cost of borrowing (including interest and fees) can add a significant financial burden.

2. Bonds

These are debt instruments in which a business borrows money from investors by issuing debt securities. The businesses pay back the original amount (the principal) on a specific date and make regular interest payments (called “coupons”) along the way. Bonds are often used by larger companies to raise money for big projects like building new facilities, buying equipment or expanding into new markets.

Like a bank loan, bonds offer predictable repayment terms, so businesses know exactly what they need to pay and when, and don’t require giving up ownership. Issuing them can be expensive though, as you’ll need legal and financial experts to help with the process. You’ll still have to make regular interest payments as well, regardless of how your business is performing.

3. Venture capital

Venture capital is funding from investors who provide money in exchange for equity in high-growth companies. This option is particularly popular in industries like tech and healthcare, where businesses need a lot of money to grow fast.

Venture capitalists often bring valuable experience, advice and connections to the table – helping with things like refining a business strategy or hiring key talent. However, in exchange for their investment, VCs usually demand a significant ownership stake and may want active participation in major business decisions, such as appointing board members, approving budgets or deciding on an exit strategy.

4. Angel investors

These are individuals who use their own money to invest in startups or small businesses, typically in exchange for equity or convertible debt. They often step in during the early stages when companies need funding to develop products, build a team or launch into the market. Unlike traditional lenders, angel investors are usually willing to take on more risk, making them a great option for startups that might struggle to secure regular bank loans or venture capital.

But to secure their support, founders typically have to give up a portion of ownership in the company, which means sharing future profits and some level of decision-making power. Angel investors may also expect a say in the direction of the business, which can sometimes create tension if their ideas and vision differ from the founder.

5. Crowdfunding

A new and modern way for businesses to raise money, crowdfunding involves collecting small contributions from a large number of people, usually through online platforms like Kickstarter, Indiegogo or GoFundMe. Many businesses have taken up crowdfunding for its flexibility, allowing them to tap into a wider audience, such as potential customers and investors, to fund projects, launch products or scale operations.

But despite its potential, creating a successful campaign requires a lot of effort, including a strong marketing strategy and ongoing engagement with backers. There’s also no guarantee that the campaign will reach its funding goals, and on some platforms, failing to meet the target means the business won’t receive any of the pledged funds.

6. Leasing

This is where businesses can use equipment, vehicles or property without purchasing them outright. Instead, they pay a set amount periodically (usually monthly or quarterly) to use the asset for a fixed term. At the end of the lease, businesses typically have the option to purchase the asset, renew the lease, or return it.

Leasing allows businesses to access high-cost assets without needing a large upfront payment, which can be especially helpful for startups or companies with limited cash flow, as they are usually smaller than loan payments and can be spread over several years. That being said, it isn’t always the cheapest option because you might end up paying more than if you purchased it upfront. Also, as you don’t own the asset, you’ll have to continue leasing if you want to use it long term.

Conclusion

Choosing the right financing option for your business is a big decision, but it ultimately depends on your goals, financial situation and how much risk you’re willing to take. Whether you go for debt or equity, each option comes with its own pros and cons.

Short term sources like bank overdrafts and MCAs are great for covering immediate needs, but they can come with higher costs and risks. On the other hand, long term options like bank loans, venture capital and bonds can provide the stability you need for bigger projects and growth but may require a bit more paperwork.

Remember, it’s not just about getting money – it’s about getting the right kind of money that aligns with your business needs and future plans. Therefore, you should take your time, weigh your options and choose what works best for your business to help it grow successfully.