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Small Business Financing
Small Business Financing
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Small business financing (also referred to as startup financing or franchise financing) refers
to the means by which an aspiring or current business owner obtains money to start a
new small business, purchase an existing small business or bring money into an existing small
business to finance current or future business activity. There are many ways to finance a new
or existing business, each of which features its own benefits and limitations. In the wake of
the financial crisis of 200708, the availability of traditional types of small business financing
dramatically decreased.[1] At the same time, alternative types of small business financing have
emerged. In this context, it is instructive to divide the types of small business financing into the
two broad categories of traditional and alternative small business financing options.
Contents
[hide]
2Debt Financing
3Equity Financing
6References
Debt Financing[edit]
The principal advantages of borrowing funds to finance a new or existing small business are
typically that the lender will not have any say in how the business is managed and will not be
entitled to any of the profits that the business generates. The disadvantages are the payments
may be especially burdensome for businesses that are new or expanding.
Failure to make required loan payments will risk forfeiture of assets (including
possibly personal assets of the business owners) that are pledged as security for
the loan.
The credit approval process may result in some aspiring or existing business
owners not qualifying for financing or only qualifying for high interest loans or loans
that require the pledge of personal assets as collateral. In addition, the time
required to obtain credit approval may be significant.
Excessive debt may overwhelm the business and ultimately risks bankruptcy. For
example, a business that carries a heavy debt burden may face an increased risk
of failure.[2]
The sources of debt financing may include conventional lenders (banks, credit unions,
etc.), friends and family, Small Business Administration (SBA) loans, technology based
lenders,[3][4][5] microlenders, home equity loans and personal credit cards. Small business
owners in the US borrow, on average, $23,000 from friends and family to start their
business.[6]
The duration of a business loan is variable and could range from one week to five or more
years, and speed of access to funds will depend on the lender's internal processes. Private
lenders are swift in turnaround times and can in many cases settle funds on the same day
as the application, whereas traditional big banks can take weeks or months.
Equity Financing[edit]
The principal practical advantage of selling an ownership interest to finance a new or
existing small business is that the business may use the equity investment to run the
business rather than making potentially burdensome loan payments. In addition, the
business and the business owner(s) will typically not have to repay the investors in the
event that the business loses money or ultimately fails. The disadvantages of equity
financing include the following:
By selling an ownership interest, the entrepreneur will dilute his or her control of
the business.
In certain circumstances, equity financing may require compliance with federal and
state securities laws.
The sources of equity financing may include friends and family, angel investors, and
venture capitalists.
This small business financing option allows the business owner to obtain the benefits
of debt and equity financing while avoiding the disadvantages such as burdensome
debt payments. More than 10,000 entrepreneurs have used their retirement funds to
finance their start-up businesses.[8]
The IRS has clearly stated that the use of retirement funds to finance a small business
is not per se non-compliant. ROBS financing is complicated, however, and the IRS
has developed a set of guidelines for ROBS financing.[9] As such it is essential to
employ experienced professionals to assist with this small business financing strategy.
References[edit]
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