Funds are the lifeline of a business. Capital is needed to start a business and financing solutions are also necessary to catapult the business into new levels of growth or expansion. 

It doesn’t matter if your business is a corporation, a partnership or a sole proprietorship, you’ll need funds to meet financial obligations, such as paying suppliers, and meet your goals like adding a new product or service. As the saying goes, you have to spend money to make money. 

You can get access to funds for your business operations from several sources. Let’s go through some of them below. 

Equity Financing

When you let an individual or a firm invest in your business and in return give them a share in the ownership of that business in the form of shares in profit, you’ve just taken advantage of equity financing. This is a long-term investment that will stand as long as the individual or firm doesn’t sell their shares to another person or company. 

This ownership typically comes in the form of common or preferred shares of stock. Or, in the case of a limited liability company, ownership is through membership units. It’s a good way to raise funds without incurring debt, though some control over the business is given up in the process.

Companies typically hold an initial public offering (IPO) or equity offerings, where shares of stock are sold to the public. The company doesn’t have to repay this investment, but it is still a quid pro quo arrangement. Being one of the owners of the business, stockholders now have a share in the profits of the business.

In the case of companies, some types of stocks even have a say in how the corporation is being run. Common stocks usually give their owners a right to vote as well. However, preferred stockholders generally come before common stockholders when it comes to dividends, which is their share in the profits, as well as when getting paid back in their investment in the event of bankruptcy. 

Other forms of equity financing include: 

  • Venture capital – Private investors or investment banks can provide funding, along with guidance and advice, for startups and small businesses. As a form of private equity, investors receive ownership shares in the business so they have a say in the way the business is run. In terms of return on their investment, they’re ideally looking for 50% or more. 
  • Angel investors – While they’re still looking to profit from their investment, angel investors have more than money on their mind. They can invest in a business if it helps them achieve their mission, for instance, of developing a certain area. So, they’re more likely to provide smaller funds in the earlier stages of the business. 

While the most popular example of this form of business financing is a corporation’s share of stocks, the following examples are also considered equity financing:

  • Personal savings – This can be in the form of cash value insurance policies, early retirement funds, or real estate equity loans. 
  • Investments from family, relatives and friends – Family and friends can lend a hand in starting or growing your business by investing in it. Put everything in writing and use the money as you would investments from other investors.
  • Government grants – You can also start up or expand your business through the help of federal or state government financial assistance. 

Debt Financing

In one word: loan. It is perhaps one of the most common ways people usually think of when they need to access funds to start or grow their business. Unlike investments which will only take a share in profits, debts have to be paid off. You’ll need to pay the principal and interest on a regular payment schedule which is typically monthly.

Debt financing can be secured or unsecured. A secured loan will require collateral, which can be taken away by the lender if you default on your loan. Businesses can apply for a short-term loan or a long-term loan, depending on their needs.  Before you receive the loan, however, you’ll have to go through a lengthy process, which can include evaluation of the business’ ability to pay. 

Major sources of business loans include: 

  • Banks and other financial institutions – While they are the most popular sources of business financing, start-ups generally have a hard time getting a loan from them. This is because they require borrowers to prove that they can pay back their debt and without financial statements that’s hard to do. However, once the business is profitable, banks and other commercial lenders might be more easy to borrow from.
  • Bonds – This is a debt instrument that companies issue to raise funds. Bonds have a maturity date which is when the company will pay back the principal. It’s a win-win for both parties, as the company will be able to use the funds before paying them back while the bond holders will be guaranteed payment ahead of dividend payments to stockholders. 
  • Government financial assistance programs – Examples include the loan guarantee programs of the Small Business Administration (SBA) and the USDA Rural Development program. The SBA guarantees loans secured from private lenders, while the USDA Rural Development program does the same but focuses on rural businesses, such as cooperatives, federally recognized tribes, and other small businesses.
  • Loans from family, relatives and friends – Family and friends can also be a good source of funds. You can loan an amount from them that you’ll pay with interest in specific repayment terms. It’s recommended that this should be executed as a formal loan and include a collateral in case of default.

Retained Earnings

If you’re thinking of expanding your business, perhaps the best way to go about it is to reinvest the profits back into the business. Retained earnings is simply the leftover funds after the business has paid off its expenses and other obligations, such as debt and dividends. The leftover money can then be reinvested into opening a new location or developing or launching a new product or service, for instance. 

How to Choose the Right Financing for Your Business

There are many sources of business financing, but you have to think carefully on which one you’ll go with as each has their own pros and cons. It’s important to weigh the advantages and disadvantages of each source of business financing and compare them to your goal. 

For instance, if you don’t mind losing some control over your business, then finding investors will be okay with you. But, if you want total control over your business, then look for other sources of funds that will let you retain that control.

Another thing to keep in mind is your ability to pay back what you owe or fulfill any obligations attached to those funds. For instance, debts from banks will always need to be paid on time to avoid incurring penalties and fees. But, your parents might be a little bit forgiving and understanding.

How Does a Business Finance Its Operations?

In conclusion, businesses finance their operations through equity financing, debt financing, and retained earnings, each with its own advantages and considerations. Choose wisely.