Unlike what most small business owners think, funding a business is not rocket science. In truth, there are only three major ways to perform it: via debt, equity or what I call "do it yourself" finance.
Each approach comes with benefits and drawbacks you should take note of. At various stages in your business's life cycle, one or more of these methods may be appropriate. For that reason, a complete knowledge of each method is crucial if you think you may ever have to secure funding for your business.
Debt and Equity: Pros and Cons
Debt and equity are what many people think of when you ask them about business financing. Traditional debt financing is often provided by banks, which loan money that must be repaid with interest within a certain time frame. These loans generally must be secured by collateral in case they can not be repaid.
The cost of debt is relatively low, especially in today's low-interest-rate atmosphere. However, business loans have become harder to come by in the current tight credit environment.
Equity financing is given by investors who receive shares of ownership in the company, in lieu of interest, in exchange for their money. These are typically venture capitalists, private equity firms and angel investors. While equity financing does not have to be repaid like a bank loan does, the cost over time can be much more than debt.
This is because each share of ownership you divest to an investor is an ownership share out of your pocket that has an unknown future value. Equity investors often place terms and conditions on funding that can chain owners, and they count on a very high rate of return on the companies they invest in.
My preferred kind of financing is the do-it-yourself, or DIY, variety. And one of the best ways to DIY is by using a financing technique called invoice discounting. With receivable factoring products, companies sell their outstanding receivables to a commercial finance company (sometimes referred to as a " factoring company") at a discount. There are two key benefits of factoring:.
Significantly bolstered cash flow As opposed to standing by http://accountsreceivablefinance.org/ to receive payment, the business gets the majority of the accounts receivable when the invoice is generated. This reduction in the receivables delay can mean the difference between success and failure for companies operating on long cash flow cycles.
No more credit analysis, risk or collections The finance company conducts credit checks on customers and analyzes credit reports to uncover bad risks and set appropriate credit limits essentially becoming the businesss full-time credit manager. It also performs all the services of a full-fledged accounts receivable (A/R) department, including folding, stuffing, mailing and documenting invoices and payments in an accounting system.
Factoring is not as well-known as debt and equity, but it's often more practical as a business financing instrument. One reason many owners don't consider invoice factoring first is because it takes some time and energy to make invoice factoring work. Lot of people today are looking for fast answers and immediate results, but quick fixes are not always readily available or advisable.
Getting it to Work.
For factoring to function, the business must accomplish one extremely important thing: deliver a quality product or service to a creditworthy customer. Naturally, this is something the business was created to perform to begin with, but it functions as a built-in incentive so the business owner does not forget what he or she should be doing anyway.
Once the customer is satisfied, the business will be paid immediately by the factoring company it doesn't need to wait 30, 60 or 90 days or longer to receive payment. The business can then immediately pay its suppliers and reinvest the profits back into the company. It can employ these profits to pay any past-due items, obtain discounts from suppliers or increase sales. These benefits will typically more than offset the fees paid to the invoice factoring company.
By receivable factoring, a business can boost its sales, develop strong supplier relationships and enhance its financial statements. And by relying upon the factoring company's A/R management programs, the business owner can work on growing sales and raising profitability. All of this can happen without increasing debt or diluting equity.
The typical business uses factoring companies for about 18 months, which is the period of time it usually requires to accomplish growth objectives, pay off past-due amounts and boost the balance sheet. Then the business will likely be in a better position to pursue debt and equity opportunities if it still needs to.