If you are a business owner keen to take your business to the next level, you may have found that the growth you want needs extra capital to fuel it. However, accessing capital is not an easy task. There are so many different sources of capital and finding the right one to suit you and your business is complex. Yet it is vital to find a form of financing that meets your requirements. Making the wrong choice can diminish your business’s ability to grow to its true potential.
In this article, we look at why a business may require extra capital, as well as how to find capital for your specific business needs. In the process, we investigate what exactly capital financing is, and in doing so, we explore both debt and equity financing – two of the most common sources of capital finance for business owners. By defining what exactly debt and equity financing is, we also highlight the advantages and disadvantages of both so business owners can ascertain the suitability of each.
Businesses often need extra capital to grow. Growth is what can make a business more productive by generating better profit margins in the future. However, growth is often driven by investment which, of course, needs capital. Investment can be anything from hiring a new employee, buying more equipment or taking out a new lease on business premises.
As a business owner, you will be the one who will need to identify how and where your business can grow in a sustained fashion. It is down to you to calculate how much extra capital you need to make the changes you believe will benefit your firm. Once you have a figure in mind, you will be able to better understand where to access that investment from.
Capital financing is the act of raising funds from sources outside your business. This can be done in a variety of ways, most commonly through finding an equity investor or by taking out a loan to have a debt on your balance sheet.
All forms of raising capital for your firm come with pros and cons. It is therefore important when weighing up the advantages and disadvantages of each form of financing to keep your future vision of your business in mind. Not only will this give you the motivation to proceed with finding finance, it will also help inform your decision on which is best suited to your business needs. You will then be able to channel the consequent funds raised into your firm in the most constructive way possible having accessed the right sort of financing for you.
Equity financing is, in essence, finding a business partner who is happy to invest cash in your company. In doing so, the prospective investor will be buying a part of your business and therefore part of the potential future profits.
There are a number of big benefits to this type of financing. Firstly, you do not have to pay the money back. No debt is put on to your balance sheet and there are no costly interest repayments you need to make.
Secondly, and maybe the biggest benefit to having a business partner is that they can have a huge amount of experience and contacts which you can leverage to help make the gains which your business is capable. Bearing that in mind, their cash injection as well as their knowledge can both be seen as invaluable and a big driver in your business’s future success.
Finally, equity financing can be a quick way to raise the necessary funds for your business. It’s a swift cash injection which can then be used to generate the growth you foresee for your firm.
Without doubt, however, the biggest drawback to this type of financing model is that you dilute your ownership. In some instances, you may find you do still have the most influence over your business and the direction it takes in comparison to your new investor. As a consequence, in situations like this, you will still be able to make all the decisions required to drive your business forward.
However, that is not always the case. In fact, most equity investors will have a keen interest in the business in an effort to protect the cash they have invested. Bear in mind that your views may not always be the same and differences of opinion will occur. Before taking on this form of financing, therefore, you need to ask whether you are happy to share any decision-making power. For this reason, so much of raising equity investment is also down to how well you can work with the investor. Personality needs to be taken into account to see whether your partnership can be truly productive.
Additionally, you have to ask yourself whether you are happy to share the profits, maybe indefinitely, your business produces. As an equity investor, your new business partner will have rights to profit-share with you. The idea of profit sharing is never one that business owners are especially keen on initially. Ultimately, though, if those profits are that much larger thanks to the investment and knowledge from your business partner, it could be a financially beneficial decision to make overall.
Raising funds through debt financing can, in itself, take many forms. Some companies may be able to invest in their company simply through the use of a credit card. However, more common (and often more efficient) means of debt financing will come in the form of bank loans, a lease contract or lines of credit from a supplier. These will all be forms of debt on a business’s balance sheet that need to be taken into account before any profits are taken.
The pros of accessing debt to finance business investment is that, in stark comparison to equity financing, you remain the sole owner of your company. To run an autonomous business is fundamental to so many business owners – particularly in the SME space. It is one of the main reasons that individuals start companies in the first place. Business owners often like to be their own boss and only have to answer to themselves.
Other pros to taking out loans to finance future investment is that sometimes only a small loan or line of credit is necessary. The result is, the loan or debt is paid back easily over time, growth is still achieved, and the business owner still takes home 100% of the profits. Interest payments on loans also attracts tax relief, this means the effective interest rate is actually reduced. Provided you achieve your growth objectives, once he loan is repaid your profits after tax are all yours.
Of course, the drawback to taking out debt is that it can be costly to pay back. Interest repayment on loans can eat away at profits generated by the investment in the first place. In fact, it is not uncommon to see companies not make a profit due to the debt that they take on. Not only that, but there are other fees you need to take into account. Loans or debt are, therefore, sometimes not an option for some businesses where business owners need to take home some profit for their income. Depending on your business size and the assets you hold in the business, lenders may wish to take a debenture on your business assets. A debenture will help the lender to recover some of their money should you default. If your business has no assets a lender may demand company directors sign a personal guarantee.
Debt can also be complicated. The sheer number of loans available, all at different rates, is a hugely intimidating task, but getting it right so that your company can grow is vital. Complexity due to the structure of loans is therefore a major disadvantage. Some business owners may miss out on loans that are ideal for them due to the sheer breadth and depth of the loans market.
Finally, simply having to make regular repayments on a loan may be tricky for some businesses. The nature of some investments will be that any money made as a result of the investment will only be realised after some time. However, repayments are often required in monthly instalments soon after the initial loan has been made. Not being able to repay the debt from the outset may preclude some business owners from even taking out a loan in the first instance.
Discovering the right funding options for you and your business is vital. If you are wondering how to find capital for your business needs, it can be beneficial to look for professional insight from an expert in the field. Firms with a great deal of expertise, such as Finance Equation Ltd, seek to take the complexity out of making the best financial decisions for you and your business. One way of doing this is to create business models that allow you to evaluate the different options available to you. Our experienced part time finance director service maybe just what is needed to help you deal with Banks or investors.
In doing so, you can always be sure you are accessing the right form of funding that you need and that will answer your business’s needs. The result is that you can use those funds to enhance and elevate your company to a higher level where profits are maximised through effective investment decisions that help fuel productivity.
Finance Equation Ltd are multi-award-winning Chartered Certified Accountants providing cutting-edge expert services to individuals, property investors, businesses and contractors. We specialise in serving small, medium and large companies. We understand our clients’ needs and are passionate about providing the right advice and expertise to save you money.
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The Finance Equation Ltd is a company registered in England & Wales. Company number 05116983.
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