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Business Financing Options

by Jonathan Roe

Overview

Finding fair financing for a business is one of the most difficult tasks an owner will encounter. There are many options for business financing out there, but what an owner can actually make use of will depend on a myriad of factors such as how much equity the owner has in the business, how many years the company has been in business, how much control the owner is willing to give up, and what the current economic environment looks like.
Bootstrapping

Bootstrapping a business is a time-honored tradition that has gotten many a small start-up off the ground and running. Most people who started a business out of their garage or their dorm room initially bootstrapped their business. They relied on personal savings and credit cards, loans from parents and friends, and occasionally a business partner who was willing to extend them credit to help them deliver a needed service. Bootstrapping is difficult and a lack of money is the leading cause of business failure, but it does instill a mindset of frugality. Careful consideration is given to every business expenditure, a practice that will later serve the business owner well.

Venture Capital

The second business financing option is to make use of venture capital. Often called angel investors, these individuals or private equity groups can provide large amounts of financing for a company. Their price is steep, and they will often demand seats on the board and a large equity stake. In return, they will give an owner access to further financing and will leverage all of their contacts to try and ensure success of the venture.
Commercial Banks

Business financing from commercial banks is usually only available to a company that has a considerable track record or has owners with fairly deep pockets. A commercial bank will often demand collateral and will establish several financial tests (called loan covenants). The covenants can demand any number of things but often demand that certain leverage ratios, debt service coverage ratios, and minimum net worth ratios be maintained. Financing from commercial banks is difficult to get but it is often the cheapest form of financing.
Which One to Use?

Each financing option has its own pros and cons. Bootstrapping is attractive because of the amount of control the owner retains. The problem is that even though the owner has full control, he has few options due to his lack of cash. Commercial bank financing is the second most attractive due to the owner being able to retain control of the equity of the company, but few people starting out can talk a bank into lending to them. While venture capital might seem like a good choice, it can often be as difficult to get as a commercial bank loan.
The Typical Company

The average owner who finds himself in need of business financing usually works his way through each stage of the financing cycle. The initial phase is funded out of his own pocket until he has a bit of a track record. Then he will approach a private equity group for venture capital to take him to the next level. Once there, the venture capitalist will help the owner establish a commercial banking relationship. So when going over the options, do not think that each option is exclusive of the other. Every good business owner uses each option when it becomes appropriate.