One of the major concerns an aspiring business owner has at the initial stages of the venture is financing the business. The two traditional sources of funding when starting or purchasing a business are debt and equity financing. Increasingly however, alternative funding methods are being used by small business for the access and flexibility they provide in comparison to traditional financing.
Debt financing. Debt financing allows borrowers access to funds from a lending source pursuant to an agreement to repay the principal and make interest payments at a specified rate. Banks typically provide loans accounting for up to 60% of the total price of the business. A business owner who wants to obtain bank financing exclusively must present a comprehensive and persuasive case to qualify for a loan, which includes information about the future business, the nature of the collateral, and a loan repayment plan. Small businesses often face significant obstacles in obtaining long-term financing from a bank. As an alternative, a business owner can seek private debt financing from investors, such as friends, family, or other entrepreneurs. Qualifications for private financing depends on the lender.
Equity financing. An alternative to acquiring debt to fund a business is equity financing. This entails a purchaser offering stock or shares of the business to outside investors. In exchange for providing financing, the investors, often referred to as venture capitalists, retain partial ownership of the business. Similarly, businesses have been increasingly selling stocks or shares through crowdfunding platforms. Crowdfunding is the process of raising capital from a large group of contributors in an online venue. New rules recently issued by the Securities and Exchange Commission enable small businesses to raise capital from non-high net worth individuals in the public arena and allow members of the public to participate in investment opportunities for start-up ventures.
Seller financing. In a seller financed transaction, the purchaser obtains financing directly from the seller of the business and repays the loan. Loan repayment usually occurs within three to five years. A business venture that is financed through this method may demand a higher sale price to offset the risk incurred by the seller. But seller financing may offer additional negotiating leverage for the purchaser as compared to traditional bank financing.
Non-alternative options. In some cases, you may find that your best financing options come from non-traditional sources. Purchasers who do not qualify for conventional loans are often forced to explore alternative methods, such as peer-to-peer financing, which is an online investment platform typically offering lower interest rates. On the plus side, alternative financing can give borrowers the opportunity to obtain smaller amounts of capital quickly and reliably.
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