Financing a Business FAQ
You have a killer business idea, but now you need the capital to make it happen. While financing a new business can seem overwhelming, it is not impossible. Here you will learn about how to raise money, the different types of loans out there, and more.
How Do Businesses Generate Financing?
Businesses have two primary ways to raise money, and which one you choose depends on how much money you need and whether you're willing to cede control to other people:
- Loans: Just like anyone else, businesses obtain financing by borrowing money from friends, family members and banks. Most banks have special divisions that deal with commercial banking (as opposed to personal banking), so a good way to familiarize yourself with how bank loans work for businesses is to inquire at your own bank.
- Equity: Businesses also regularly give away a part of themselves, known as an equity interest, in return for financing. Instead of taking a loan, a business might sell a percentage of its profits to an investor and receive a sum of money in return. This can be an effective way to raise money without incurring massive debts.
Are Business Loans any Different than Regular Loans?
Business loans are largely similar to personal loans. You and the lender will agree on the amount of the loan, the interest rate, and the repayment schedule before signing an agreement. Just like any other loan, a bank may require that you provide collateral for the loan, which for businesses can often be business equipment, property, etc.
What Kind of Repayment Options are there for Business Loans?
Just like any other loan, the most common form of repayment is typically a monthly payment that goes toward both the principal and the interest on the loan. Some businesses, however, structure repayment so that they initially have a much lower monthly payment for a period of time until the business is expected to become profitable. At that point, the monthly payment increases to cover the cost of the initially lower payments and may end in a balloon payment coming due. Finally, some businesses structure their repayment so that it largely covers the interest portion of the loan before applying payments to the principal of the loan.
How Does Selling an Ownership Interest in my Business Differ from a Loan?
When taking out a loan, money is borrowed and then repaid over a period of time. In contrast, when selling an ownership interest, money is given in return for a stake in the business and no repayment is due. Selling an ownership interest is just a business transaction like any other - you sell a piece of the company and get money in return.
Investors are willing to do this because they will generally ask for a percentage of the company's profits in return. To them, it is an investment, and they expect that the profits generated will exceed the amount they initially put in.
While not having a loan to repay may sound nice, the catch is that someone else now owns a portion of your business and now has substantial rights and the ability to control the company to some extent. This can be a good or bad thing depending on you, your business and the investors.
How Do I Sell an Ownership Interest in my Business?
In order to grant an ownership interest into your business, you'll first have to decide how to organize the business. If you do nothing and simply execute a contract granting investors a portion of the company, then by default you'll most likely have created a general partnership. General partnerships are usually avoided, however, because the investors (as well as the founder) are personally liable for the debts and liability incurred by the business.
Most businesses prefer to organize as one of the "limited liability" organizations available to businesses such as corporations, limited liability companies or limited partnerships. Each one of these organizational structures provides some sort of protection for equity holders against business debts and liability.
Legal Help with Financing
Knowing where and how to secure financing for your new business is the first step in making your dreams a reality. However, not knowing the legal ramifications of your choice can make those dreams into one big nightmare. Speak to a qualified business law attorney today before you choose how to fund your business.
For more information, see FindLaw's section on Starting a Business.