One of the biggest challenges that business owners face is financing. Financing comes in many forms such as equity, crowdfunding, debt, invoice factoring/financing, loans, etc. Regardless of the method that you opt for in order to fiancé your business, there are advantages and disadvantages associated with each option.
Regardless of the option you take, you should bear in mind the following:
Dilution of Ownership
Under the equity method of financing, a shareholder or a group of them bring in funds in exchange for a percentage of ownership in the business. This means, therefore, that the founders / original owners have their control of the organization diluted. This method of financing is relatively cheaper since dividends will only be paid when profits are made. None will be distributed in the event that the business has made losses.
Any business owner who wants to maintain tight control over the operations of his company should not use equity financing.
Debt financing, on the other hand, does not give the lenders any percentage of ownership in the company. They are strictly viewed as lenders to the business.
A lot of businesses do not have enough assets that can be pledged as collateral when securing loans. This means, therefore, that they may be forced to opt for options such as issuing new shares.
When lenders such banks are approving loans, they look at factors such as the cash flow and credit history. Credit worthiness will determine how risky a borrower is. Consequently, financial institutions tend to either impose a higher interest rate on borrowers who are risky or completely deny them the loan facilities.
There are lenders who have structured their products in such a way that your loan facility is priced according to your credit history. There are installment loans for poor credit and one-off loans for good credit. These arrangements enable lenders to manage their risks well.
Other financing plans may not factor in the credit history not cash flow trends of the business. Crowd-funders, for example, look at the long term prospects of the business while invoice factoring may be interested in the company that was supplied with the goods and the institution that will pay the invoice.
Cost of Finance
Cost of finance has been defined as the price that borrowers pay for using a specific mode of financing. The cost of finance for equity is dividends while debt attracts interest. Different costs of finance have different tax implications. Secondly, dividends may be deferred until the business is in a healthy cash flow position. On the other hand, interest on loans is at most given a grace period of one month before repayments are demanded.
Taking a loan to finance your business is still the best option since the repayments are well known in advance. There is also no risk of diluting the ownership of the business. Bringing more people on board may slow down decision-making processes. Lastly, in the event that the collaterals are a bit scarce, take loans in small bits such that the available assets can cover the uptakes.