Sources of Debt Financing and Equity Financing

Funding is needed to start a business. There are several sources to consider when seeking initial funding. The financial needs of a company are depending on the type and size of the company. Once the topic is completed and approved, learners will be able to…make a difference between Debt Financing and Equity Financing.

In this lesson, we will talk more about Debt and Equity Financing, which are the two main sources of financing.

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Sources of Debt Financing

Property-backed loans are secured by real assets and include mortgages, equipment loans, and inventory loans.

Unsecured business loans, such as term loans, do not require any real assets as collateral and are often used to finance working capital, business expansion, and acquisition.

Lines of credit are temporary, short-term unsecured loans that are common it is used for seasonal cash needs or for emergency funds.

Factoring, technically (legally) is not a loan. Companies specializing in factoring receivables, purchase orders factoring and a cash advance in a company or merchant provide cash to business owners in exchange for future revenue or customer payments.

Banks, from large commercial banks to local savings and loans, have traditionally been the primary source of financing for small businesses (Book Entrepreneurial Finance Concepts and Cases, 2020).

Peer-to-peer (P2P) lending is a relatively new source of debt financing for individuals and businesses (Book Entrepreneurial Finance Concepts and Cases, 2020). The business model of most P2P lending companies is the direct connection between small businesses and individual borrowers with investors.

Accounts Receivable Financing, also known as account financing or accounts receivables factoring, is another source of funds for small businesses.

There are two types of receivables financing:

1. Non-recourse factoring (Financing company takes responsibility for collecting payments from the business’ customers)
2. Recourse factoring (Financing company purchases account receivables from the business, but in the event of non-payment by customers, the business has to buy back these bad accounts receivables)

Merchant Cash Advance - Variety of small business financing options characterized by short payment deadlines and small regular payments.

Resource: Pixabay

Sources of Equity Financing

Angel Investors - Highly regarded person who provides financial support to small startups or entrepreneurs, usually in exchange for capital in the company.

SBA – Small Business Investment Company (SBIC) - Small business investment companies supply small businesses with financing in both equity and debt(Book Entrepreneurial Finance Concepts and Cases, 2020).

Venture capital - The type of financing that investors provide to startups and small businesses that they believe have long-term growth potential (Venture Capital, 2020).

Crowdfunding - The practice of financing a project or venture by raising money from a large number of people who contribute a relatively small amount, usually through the Internet (Crowdfunding).

Conclusions

An entrepreneur's dream or idea cannot be realized without some kind of cash flow into the business. For a start-up, it usually starts with a certain stakeholder investment, and can also include money from friends or family members. As the business grows, the property will have to turn to a third party for additional funding.

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