Everything You Need to Know About Business Finance
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Editor’s note: Lantern by SoFi seeks to provide content that is objective, independent and accurate. Writers are separate from our business operation and do not receive direct compensation from advertisers or partners. Read more about our Editorial Guidelines and How We Make Money.
What Is Business Financing?
How Does Business Financing Work?
3 Types of Business Financing
1. Equity Financing
What Is Equity Financing?
Pros and Cons of Equity Financing
Money does not have to be paid back No monthly payments, leaving more liquid cash available for operating expenses Funding without pressure (investors generally understand that it can take time for a business to thrive) Investors may offer operational expertise and valuable business connections Requires giving up ownership of a portion of your company Typically must share profits indefinitely May need to consult with investors on decisions If an investor purchases more than 50% of your business, you will become a minority owner
Example of Equity Financing
2. Debt Financing
What Is Debt Financing?
Installment loans With this setup, you receive funding from a lender upfront and repay it (plus interest) over time according to a fixed schedule. Also referred to as term loans, these loans may be secured (which means they require collateral) or unsecured (no collateral required). Revolving loans This gives you access to a set line of credit that you can draw from as needed. You only pay interest on the funds you use, and once you’ve repaid what you’ve borrowed, you have access to the line of credit again. Business credit cards and lines of credit are two common examples of a revolving loan. Cash flow loans A cash flow loan is a type of unsecured borrowing that is used for the day-to-day operations of a small business. With this type of loan, you borrow against your future revenue and repay the loan with incoming cash flows of the business. Offered by alternative lenders, this type of loan can be easier to qualify for than a conventional term loan. However, interest rates tend to be higher. Merchant cash advances and invoice financing are examples of cash flow loans. Short-term debt financing (which generally has a repayment period of 12 months or less) Long-term debt financing (which has a repayment term up to 10 years, and in some cases, as long as 25 years).
Pros and Cons of Debt Financing
Maintain ownership and full control of the company Interest is typically tax deductible as a business expense When the loan is paid off, the lender is no longer in the picture Responsibly paying off a loan can help build business credit Can be difficult to qualify for loans with the best rates and terms Involves making monthly payments (even when business is slow) May not be an option for startups May require collateral or a personal guarantee, which puts business or personal assets at risk
Examples of Debt Financing
Traditional bank loans Online loans Government-backed loans, such as small business administration (SBA) loans Business lines of credit Business credit cards Equipment loans Real estate loans Crowdfunding (peer-to-peer) loans Loans from family and friends
3. Mezzanine Capital
What is Mezzanine Capital?
Pros and Cons of Mezzanine Capital
Typically doesn’t require putting up any collateral May be able to make interest-only payments in the beginning Usually involves giving up less equity than equity financing Interest on the mezzanine debt is typically tax-deductible Higher interest rate than conventional business loans Usually not available to startups or young companies May include multiple warrants Potential for dilution of equity and loss of company control
Example of Mezzanine Capital
3 Small Business Loan Tips
Generally, it can be easier for entrepreneurs starting out to qualify for a loan from an online lender than from a traditional lender. Lantern by SoFi’s single application makes it easy to find and compare small business loan offers from multiple lenders. If you are launching a new business or your business is young, lenders will consider your personal credit score. Eventually, though, you’ll want to establish your business credit. SBA loans are guaranteed by the U.S. Small Business Administration and typically offer favorable terms. They can also have more complicated applications and requirements than non-SBA business loans.
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