Types of Business Finance

Running a successful business is one of the biggest challenges entrepreneurs face, with many day-to-day operational expenses that need active cash flow in the business. Many successful businesses need funding to support working capital and fuel growth plans.

For many businesses, having reliable cash flow finance can help them survive and even thrive. When cash flow becomes stretched, the business must explore financial options that alleviate the cash crunch and sustain business operations.

If you’re considering your business finance options, this guide will come in handy as it reviews the different options you can consider and what you can use the funds for.

What is Business Finance?

Business finance is the process of arranging funds for the successful operation of the business. However, it is not limited to arranging for funds for business operations but can also extend to accounting and administration of the finances incurred by the company.

In a world where survival is key, business finance is critical in ensuring the business’s survival.

Benefits of business finances

To stay on track

Business finance is a great way for entrepreneurs to track revenue and expenses. In addition, entrepreneurs are believed to use cash flow statements to understand the company’s financial position.

Improve daily operations

Organisations need funds to keep business running. With the help of adequate business finances, the business can run various functions smoothly. Borrowing business finance can help with daily operations and facilitate the organisation in achieving its goals and objectives without much hassle.

Achieve long-term objectives

Business finance can also help organisations realise their long-term goals. The business can achieve its daily target using the funds without compromising quality.

Attract more business

There’s no limit to what the company can choose to do with the funds they obtain depending on the financing model. With adequate funds, the organisation can formulate a diversification strategy and attract more business. It’s a way to expand the business and raise capital for it simultaneously.

What are the Types of Business Finance?

Businesses can turn to different financing models that can be compressed into two main categories;

• Debtor finance
• Equity finance

Debt Finance

Debt financing is when companies leverage their fixed or other assets to raise capital. It includes bank loans and bonds, which are some of the best examples of debt finance. Under this finance framework, the company is expected to repay the loan amount in a fixed time plus interest.

Types of debt finance

Bank loans

A bank loan can provide a large lump sum to fund the operations or expansion of a business. It requires the business to have a strong credit rating, and the principal plus interest must be repaid over a set period through regular payments.

Loans, though handy, are a rigid type of business finance often out of reach for small and new businesses. The application process is lengthy, often stretching several months, and the banks have strict lending criteria that demand you submit a detailed business plan, provide collateral and have a strong financial track record.

Business credit cards

Business credit cards can support working capital and cover small business expenses. The cards are more accessible than a business loan. However, their interest rates and fees can be expensive and quickly add up if you don’t clear your balance every month.

Invoice finance

Invoice finance is a more flexible funding solution that allows a business to turn its outstanding sales invoices into a source of readily available funding. The business doesn’t have to wait over a month for customers to pay. It can instead use invoice finance to receive up to 80% of the invoice value as a cash advance. Once the customer pays the invoice, you get the balance less the fees for the service.

Invoice finance differs from bank loans in many ways. For instance, you don’t need any real estate property as collateral, and the application and processing times are much shorter.

There are two main types of invoice financing: factoring and discounting;

• Factoring – Invoice Factoring is a funding facility where companies actively sell their account receivables for up to 95% of the value of the unpaid invoice upfront. Once the invoice is submitted for factoring, the finance company may absorb the responsibility of collecting payment from the customer. When your customers settle their accounts, you receive the balance less the fees for the service provided.
• Discounting – The main difference between factoring and invoice discounting is that in the latter, the company retains ownership of the invoices but still receives a specified percentage of the total value of the invoice upfront. Also, with invoice discounting, the responsibility to collect the payment remains with the business. The balance of the capital is released by the financial institution once all the invoices are duly settled.

Asset finance

Asset finance helps a business fund the purchase of high-value assets, including new and second-hand equipment and vehicles.

This type of financing is highly rigid in terms of what the business can use the finances for and typically involves hire purchasing, finance leasing and operating leasing.

Unlike traditional loans, the asset the business wants to purchase is the collateral for the funding. There is no need for property security. The business makes regular repayments to repay the principal and interest over a set period.

Trade finance

Another business finance option is trade finance, which is ideal for companies in the export and import business. This type of finance helps these companies cover cash flow gaps and mitigate the risks of international trading. It can also be used for domestic trade and other solutions like supply chain finance.

The company uses a third party to finance a transaction, ensuring the supplier they will be paid once the goods are shipped. Also, in this case, the buyer has some protections to ensure they will receive the goods they are purchasing.

Buyers can also use the trade finance option to cover cash flow gaps while waiting for shipments. They can use the funding to negotiate early payments and bulk buying discounts. Suppliers can release the money tied up in goods sold and speed up cash cycles.

Line of credit

The line of credit is a unique type of business finance that helps the business pay for emergencies and everyday expenses and even fund an expansion. It works more or less like a business credit card or overdraft.

Using the line of credit, you draw on the available credit when needed. As you take out the funds, the credit limit decreases, and when you repay the funds, the credit limit increases. This rolling fund remains active as long as you keep up with the payments.

This type of business finance is often used alongside an invoice finance facility. With a line of credit, you only draw funds when you need them and pay them back when you raise and submit a new invoice to the finance company.

Merchant cash advance

This financing solution is available for businesses that process significant customer card payments. The amount the business can access under this option is determined by the value of the card payments it processes.

Once you secure the funding, each time you process a card payment, a percentage of the payment value is automatically used to repay the principal and interest on the sum owed. The amount you repay in a month depends on the value of the card payments you process.

This type of business finance is excellent for businesses with seasonal sales cycles, but it has its fair share of drawbacks, among them being the higher interest rates than other types of financing.

As you can see, businesses have different types of debt finance options. And while there are quite a number of options, it’s evident that some only appeal to businesses in certain industries or processing certain types of payments.

Focusing on options that better understand your industry and benefit your business is vital when looking into the different options.

Equity Finance

The second category of business finance is equity finance. It covers a smaller range of funding solutions with different features and properties.

With all types of equity finance, you must give up a stake in your business in exchange for funding. There are no repayments or interests, but you must share some control and profits with those who give you the funding.

Types of equity funding include;

Crowdfunding

Crowdfunding is emerging as one of the most popular ways for startups and innovative companies to get funding. It has unique benefits and features among them, not requiring the company to have strong credit or collateral to secure financing, both of which are huge stumbling blocks for start-ups because they don’t have the assets or the transaction history.

However, the start-up needs to put together a strong promotional campaign to attract the attention of potential investors.

Crowdfunding is a long-term funding solution. The business has to be willing to dedicate lots of time and effort to promote the business and make a compelling pitch. Getting crowdfunding is likely to be a long process, and there’s no guarantee you will raise the funds you need. However, it gives start-ups the flexibility to get funding even when they don’t have the requirements that conventional funding methods look at, namely strong credit or assets.

Venture capital

Venture capital is a business finance option often considered for businesses with a high growth potential. You’ll need a scalable business plan and have achieved some success already to appeal to investors.

Typically, venture capitalists will want to audit your business before wanting to invest in the business. You will need to keep your accounts and business plan up to date at all times to facilitate this.

Small businesses are often locked out of this type of equity finance because venture capitalists often look to invest significant sums of money in companies with a high chance of producing large returns.

Angel investors

This type of business finance shares similarities with venture capital. Essentially, you offer shares or part-ownership in your business in exchange for funding. You will need a detailed business plan, up-to-date accounts and growth potential to attract potential angel investors.

Unlike venture capitalists, which can be investment company, angel investors typically work along and use their own money to fund investments. Alongside investing, the investor offers experience, market connections and advice to help your business grow.

The drawback with this type of funding is finding the investor. Angel investors are not easy to find. You’ll need to attend events, dive into your network and, expand it and try to explore mutual connections to increase the chances of finding an investor.

Family and friends

Mixing business with friendship is never a good idea because it can create problems. But on rare occasions, it proves to be the ultimate partnership. Family and friends can offer financial support to help you grow your business. Some of the most successful businesses in the world today, like Amazon, started with a loan from a family member.

If you choose to explore this type of funding, you must be clear about the financing terms and how you intend to repay it. Ensure you put together a basic contract outlining the share of equity or repayment the lender will be entitled to for investing in your company.

Although this method has its challenges, it can benefit start-ups with supportive family members, and the terms of finance might be friendlier compared to all the other options.

Determining the Right Type of Business Finance for You

Identifying the right type of business finance for you can be life-saving for your business as much as the money you get from it. Choosing the right type of financing can save your business from paying unnecessary fees and provide affordable and flexible payment options that you can keep up with.

With numerous methods to choose from, choosing the right method might not be easy. To make it easier, here are a few considerations to help you identify your company’s right type of business finance.

How much capital do you need?

The last factor you should consider is how much money you need for capital. Not all methods of finance provide you access to the same volume of money. For instance, lines of credit and merchant cash advances might not provide you with the same access to funds such as asset financing, bank loans, Angel and capital investors.

Determining how much money you need is one of the ways to narrow down your options and help you determine which finance options will best serve your needs.

How quickly do you need funding?

After determining how much money you need to finance, the next question is how quickly you need the money. Most businesses can make the case that the sooner, the better, but if the money is for long-term investment, you shouldn’t have a cash flow problem going through the length of bank loan application processes. But when considering time-sensitive factors like making payroll or restocking, you need finance methods that have a quick application and disbursement process.

In such cases, businesses often turn to invoice financing. The application and approval process for such financing takes a couple of days, and the funds can be in your account in a matter of hours. However, this funding approach only works for businesses that produce invoices as part of their sales process.

Using angel investors or venture capitalists is not time definite. Sometimes, you can close the agreement within a day, and in other instances, it can take months to make any progress. Because of the uncertainty of time, businesses considering this option shouldn’t be in a hurry to secure funding.

What types of funding do you qualify for?

Some funding methods don’t qualify for all types of businesses. Take trade funding and merchant cash advances, for instance. These only apply to companies in the shipping industry and those that process card payments, respectively.

Some funding methods, like bank loans, don’t favour start-ups, while others, like crowdfunding, don’t favour established businesses. It’s vital to pick a finance option that favours your business. It makes the application process easier and increases your chances of funding approval.

How much can I afford to repay per month?

Finally, you should consider how much your business can afford to pay per month. With several overheads and the big cash flow concern hanging over your head, it’s vital to map out how much your business will be able to pay per month without disrupting your operations.

If your business is maxed out, or you prefer not to add to your monthly expenses, you should consider ceding some control in the company or going for options that don’t require you to pay back, like invoice finance.

Established businesses with a determined monthly turnover can easily make projections and determine how much they can pay monthly, making them more suitable for conventional funding options like bank loans.

Final Thoughts

Every business, at multiple stages of its life, is faced with the tough decision of business financing. Whether it is a start-up looking to break through, a small business struggling with cash flow or an enterprise looking to expand, business finance is a factor every business will face several times in its lifetime.

Taking a keen look at the options available and carefully considering which method is ideal for your business is critical in ensuring you get the best results out of the funding and easily achieve the prospects of growing your business.