Small Business Financing
Content
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 2007–08, 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]
1Traditional Small Business Financing Options
2Debt Financing
3Equity Financing
4Rollover Retirement Funds to Start or Finance a Business
5New Sources of Debt and Equity Financing
6References
Traditional Small Business Financing Options[edit]
There have traditionally been two options available to aspiring or existing entrepreneurs
looking to finance their small business or franchise: borrow funds (debt financing) or sell
ownership interests in exchange for capital (equity financing).
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.
The investors are entitled to a share of the business profits.
The investors must be informed of significant business events and the
entrepreneur must act in the best interests of the investors.
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.
Rollover Retirement Funds to Start or Finance a
Business[edit]
A lesser-known but well-established means for entrepreneurs to finance a new or
existing business is to rollover their 401k, IRA or other retirement funds into their
franchise or other business venture. This financing option is often called "Rollover as
business startup" or "ROBS" financing. This isn't a loan: instead, the business owner
forms a C Corporation, which sponsors a profit sharing retirement plan. From there,
the business owner uses that company retirement plan to buy shares of his own
company, thus contributing to the company's finances.[7]
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.
New Sources of Debt and Equity Financing[edit]
In the wake of the decline of traditional small business financing, new sources of debt
and equity financing have increased including Crowdfunding and Peer-to-peer lending.
Unless small businesses have collateral and can prove revenue, banks are hesitant to
lend money. Often times start up companies and businesses operating for less than a
year do not have collateral and private money lenders or angel investors are a better
option. Private money lenders and angel investors are willing to take more risk than
banks recognizing the potential upside. Private lenders can also reach a decision
faster with approvals only going through one tier rather than being overlooked by many
levels of management.
References[edit]
1. Jump up^
From Wikipedia, the free encyclopedia
This article needs more links to other articles to help integrate it into the
encyclopedia. Please help improve this article by adding links that are relevant to
context within the existing text.(May 2014) (Learn how and when to remove this template
message)
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 2007–08, 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]
1Traditional Small Business Financing Options
2Debt Financing
3Equity Financing
4Rollover Retirement Funds to Start or Finance a Business
5New Sources of Debt and Equity Financing
6References
Traditional Small Business Financing Options[edit]
There have traditionally been two options available to aspiring or existing entrepreneurs
looking to finance their small business or franchise: borrow funds (debt financing) or sell
ownership interests in exchange for capital (equity financing).
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.
The investors are entitled to a share of the business profits.
The investors must be informed of significant business events and the
entrepreneur must act in the best interests of the investors.
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.
Rollover Retirement Funds to Start or Finance a
Business[edit]
A lesser-known but well-established means for entrepreneurs to finance a new or
existing business is to rollover their 401k, IRA or other retirement funds into their
franchise or other business venture. This financing option is often called "Rollover as
business startup" or "ROBS" financing. This isn't a loan: instead, the business owner
forms a C Corporation, which sponsors a profit sharing retirement plan. From there,
the business owner uses that company retirement plan to buy shares of his own
company, thus contributing to the company's finances.[7]
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.
New Sources of Debt and Equity Financing[edit]
In the wake of the decline of traditional small business financing, new sources of debt
and equity financing have increased including Crowdfunding and Peer-to-peer lending.
Unless small businesses have collateral and can prove revenue, banks are hesitant to
lend money. Often times start up companies and businesses operating for less than a
year do not have collateral and private money lenders or angel investors are a better
option. Private money lenders and angel investors are willing to take more risk than
banks recognizing the potential upside. Private lenders can also reach a decision
faster with approvals only going through one tier rather than being overlooked by many
levels of management.
References[edit]
1. Jump up^
