Understanding The Basics of Financing a New Business

Have you thought about how you are going to fund your business? When considering financing options, it’s a good idea to have an understanding of your financing needs as well as the types of options that available to help you start and sustain your business. In this section, SBA will help you assess the costs associated with start up and growth, the pros and cons of using your business versus your personal finances, the types of financing that exist, and the factors that banks evaluate when reviewing loan applications. We’ll even help you to determine if your business may be eligible for SBA assistance programs.

Borrowing Money

Borrowing money is one of the most common sources of funding for a small business, but obtaining a loan isn't always easy. Before you approach a lender for a loan, it is a good idea to understand as much as you can about the factors the bank will evaluate when they consider your application. This page outlines some of the key factors a lender uses to analyze a potential borrower.

Types of Financing

There are two types of financing: equity financing and debt financing. When looking for money, you must consider your company's debt-to-equity ratio. This ratio is the relation between dollars you've borrowed and dollars you've invested in your business. The more money owners have invested in their business, the easier it is to attract financing.

If your firm has a high ratio of equity to debt, you should probably seek debt financing. However, if your company has a high proportion of debt to equity, experts advise that you should increase your ownership capital (equity investment) for additional funds. That way you won't be over-leveraged to the point of jeopardizing your company's survival.

Equity Financing

Equity financing (or equity capital) is money raised by a company in exchange for a share of ownership in the business. Ownership is represented by owning shares of stock outright or having the right to convert other financial instruments into stock. Equity financing allows a business to obtain funds without incurring debt, or without having to repay a specific amount of money at a particular time.

Most small or growth-stage businesses use limited equity financing. Equity often comes from non-professional investors such as friends, relatives, employees, customers, or industry colleagues. The most common source of professional equity funding is venture capitalists. These are institutional risk takers and may be