Finance for Small Businesses
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Rather than racking up debt to finance your business, you can give ownership in exchange for the money you need. Learn what forms of business and what equity financing options can work best for your business.
Equity financing simply means selling an ownership interest in your business in exchange for capital. The most basic hurdle to obtaining equity financing is finding investors who are willing to buy into your business. But don't worry: Many small businesses have done this before you.
The amount of equity financing that you undertake may depend more upon your willingness to share management control than upon the investor appeal of the business. By selling equity interests in your business, you sacrifice some of your autonomy and management rights.
The effect of selling a large percentage of the ownership interest in your business may mean that your own investment will be short-term, unless you retain a majority interest in the business and control over future sale of the business. Of course, many small business operators are not necessarily interested in maintaining their business indefinitely, and your personal motives for pursuing a small business will determine the value you place upon business ownership.
The bottom line usually boils down to whether you would rather operate a successful business for several years and then sell your interest for a fair profit, or be repeatedly frustrated in attempts at financing a business that cannot achieve its potential because of insufficient capital.
The specific types of equity financing available to you are, to some extent, determined by the organizational form of your small business. Your choice of business form, or "entity," for your small business involves a wide spectrum of other important issues, such as the degree of personal risk involved in the type of business, tax considerations and the need to attract good business managers.
Each entity has its own unique characteristics:
If you're the kind of entrepreneur who likes complete control over your venture and as little paperwork as possible, a sole proprietorship could be right up your alley.
Many small businesses start (and remain) sole proprietorships because of the relative ease in paperwork and taxes. When you're:
establishing your business as a sole proprietorship may be your best bet.
Simply defined, a sole proprietorship is a single-owner business and the simplest form of business entity.
Like many things in life, though, simplicity often means limitations. If you're interested in equity financing for your business, a sole proprietorship is the most restrictive business organization structure you can choose.
Because a sole proprietorship, by its very nature, can only maintain one owner, equity investment is limited to whatever you have in the bank—or whatever assets you're willing to post on eBay and hope will generate the cash you need.
Aside from your personal financial portfolio — from simple savings accounts at banks to ownership of commercial real estate — you may need to borrow more money and contribute those funds as an equity investment in your business.
If you're considering debt financing instead of equity financing for your sole proprietorship, the former is usually limited to the number of personal assets you can pledge as security for a loan.
All of this isn't to say sole proprietorships are to be avoided. In many cases, they offer the prefect business organization structure for entrepreneurs.
Sole Proprietorship Advantages
A sole proprietorship can afford you the most freedom to run your new business. You can enjoy:
While these potential advantages can be a significant boon for your business, it's important to weigh them again the potential disadvantages.
Sole Proprietorship Disadvantages
While the advantages are clear, operating a sole proprietorship carries its fair share of concerns.
If you'd like more financing options and are relatively comfortable with a reasonable level of personal liability, organizing as a general or limited partnerships may provide the flexibility you're looking for.
A general partnership is defined as an association of two or more parties to operate a business for profit. Unlike a sole proprietorship, all of the risk and decision-making power is not limited to a single business owner—nor is the financing.
You and your partners can raise equity funds in several common ways:
While you do have a broader base of individuals' creditworthiness to tap into if you consider debt financing, the owners still largely determine the business's creditworthiness.
That doesn't mean there aren't other upsides to equity financing through a general partnership.
General Partnership Advantages
Opting for a general partnership spreads the managerial responsibilities and financial burden among several owners. You and your partners can capitalize on:
If you're interested in letting a few other ringmasters help run the circus, a general partnership can offer an ideal organization structure not only for equity financing but also operations. That's not to say, though, it's always the right choice for a few sharp entrepreneurs who want to do business together.
General Partnership Disadvantages
Ever action has its equal and opposite reaction, and the same is true for the disadvantages of general partnerships.
You may want to read more on this business organization structure if you're seriously considering establishing a general partnership. Or you can explore a similar partnership option: the limited partnership.