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Tips on Financing a Small Business

Written by: Ken Wisnefski

Article Overview: Many factors contribute to financing a startup business. In the beginning, your best asset is your knowledge. The following article illustrates helpful maneuvers and tips to get you on your way to growing your business from its beginnings.

Tips on Financing a Small Business

Introduction:
There are basically two ways to go about financing a new business: borrow money or sell ownership interests. Depending on whom you are borrowing the money from and your own financial situation, all of the decisions may not be completely in your control, but you need to be educated. The following delineates the steps and offers advice on how to go about your initial financing.




"Experience is a good schoolmaster but reason is a better one."




Borrow:
You may be able to borrow some cash from your hip uncle Milton who always thought there was something special about you, but for those of us who do not have this advantage, there is the option of commercial lenders.



Why it's Good:
An advantage of borrowing is though you will have to pay back the money (and then some), the lender will not have any say on how you employ the money or run your business. The lender will not be entitled to the fruits of your success. They only need be paid back the money borrowed with interest. One can usually deduct the interest payments as a business expense (which will be a good thing around tax season).



It Could Be Bad:
A downside of borrowing is that you are starting off in the red and this can bust the business before it even gets on its feet. You will be making loan payments in the very early period of your business (the most difficult time) when you will need money the most.



Borrowing money from a commercial lender may require you to use your property and business as compensation if you cannot pay off the loan on time, or at all. If you pledge personal assets rather than your business assets you run the risk of losing them in hopes of keeping the others.



Some people organize their business as a corporation or a limited liability company (because each offers owners limited liability for business debts). All commercial lenders will at this time ask the small business owner to personally guarantee the loan or to pledge personal assets in the event that the money cannot be paid back anyway, so the 'limited liability' is negated in another form.



"A moment's insight is sometimes worth a life's experience."




Investors:
You can accept people as investors instead of borrowing the money. This way you would not have to worry about paying back so much money in the crucial, beginning stages of your business. This is an advantage and there are others, but there are also disadvantages tied in with making this move.




Invite Investors:
Having investors will grant you the opportunity to put all of your money towards the startup of the business to cover initial expenses rather than dealing with a huge loan payment. The investors most likely will not have to be paid back if the business does not make it or if it winds up losing money. It is considered a risk on their part and they will have to cut their losses just as you will have to do without the extra responsibility of their choice being your responsibility.



Most people who want to invest have some sort of prior experience and will bring that experience with them to the endeavor which will be advantageous for the initial owner.



When the Investor Becomes a Pest:
The investor will not have the equity that a bank or other form of lender will have. This means that they have to be more highly compensated for their venture. This means that their 'share' of the business will be a considerable (probably larger in relation to what the loan plus the interest would be).



The investors (whether physically present at the business or not) are basically your partners. This means that all of the moves on the front line and behind the scenes are legally to be known by them. You will have to take your investors best interests in mind when making a business move even if it is contrary to your own interests.



"As we experience the world, so we act."




There are situations where the investors become 'silent' investors. This means that you are still liable to secure their finances, but they will have more distance from you in relation to day-to-day operations.



Which one?:
Both decisions are the right decision, the difference is in situation and timing. In a startup endeavor, it is advised to seek investors because you will have that extra insight and money available.



For ongoing needs, loans may be the better choice for businesses already established that can realistically pay back the loan with interest under the time constraint. Most likely the owner of a running business will not have to sacrifice personal assets in order to get approved for the loan.



Other than your own financial situation, it is good to examine the situation of potential investors. Their situation may have an affect come tax season and in the future for possible other loans or investment opportunities.

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