Business finance

Types of business finance

All businesses, big or small, need finance at some point. This is true whether they're just starting, looking to expand, purchasing equipment or just smoothing out bumps in cash flow.

In this article, we'll explore the main types of business finance available and the benefits of each.

What types of business finance are there?

There are two main types of business finance: debt finance and equity finance. Broadly speaking, debt financing is funds borrowed from a lender and repaid with interest, while equity financing is capital exchanged for part-ownership or shares in a company.

APositive are workforce experts.
Discover how we can help your business start, scale & succeed.

The two are not mutually exclusive and can be combined to form a variety of financing structures.

Financing options for small business

Running a business can be challenging. Surveys show that 1 in 5 businesses fail in their first twelve months in Australia, while a whopping 60% fail overall.

Lack of capital is one of the main reasons. That could result in insufficient investment in equipment, operations or marketing. However, the main reason is more day-to-day: cash flow management. Cash flow problems are a headache for almost 50% of Australian companies.

This means choosing the right type of finance is critical to the success or failure of your business.

Debt financing

Debt finance is a broad term that encompasses many types of finance options. They share that they do not give away part ownership, but the funds must be paid back with interest.

Loans can be short-term (from 30 days to a year) or long-term (from 1 to 5 years). Long term loans are often for more significant expenses, such as starting a business or for equipment or fixed assets.

There is also usually some sort of credit check. To determine if you're credit-worthy, finance companies may want to look at the following:

  • Your credit rating
  • Your business track record and financials
  • Your past bank history
  • Whether you've invested your own money
  • Your ability to repay the loan

Debt financing can be secured or unsecured, with secured loans attached to a fixed asset, such as property. The lender could seize the asset if you didn't meet the payments. Unsecured loans tend to be smaller and attract higher interest rates.

Advantages and disadvantages

Sources of debt financing

The main sources of debt finance include:

  • Financial institutions - a traditional lender like a bank, a building society or a credit union
  • Finance companies - non-bank financial institutions and online lenders
  • Retailers - purchasing goods through credit, which must be paid back at a later date with interest
  • Suppliers - trade credit on materials and services needed to run your business
  • Receivables finance (or invoice financing) - using your unpaid invoices as an asset to secure a loan or line of credit (we'll explore different kinds of receivables finance, such as factoring and discounting in much more detail in other articles)
  • Peer-to-peer loans - a way to match businesses looking for a loan with people looking to invest
  • Family & friends - a loan taken from people you know. Getting a formal written agreement/terms and conditions here is essential to avoid misunderstanding.
  • Equipment finance/asset finance - a loan secured against assets on a company's balance sheet or a form of funding used to lease essential equipment
  • Trade finance - a type of finance used to facilitate imports and exports
  • Supply chain finance - a form of funding initiated by large buyers to smooth the supply chain with sellers

Equity financing

Equity finance is the world of venture capitalists and angel investors. It's a risky business for the investor, but with risk comes reward. As we said at the start of this article, many companies fail. And investors (the business owner included) only see a repayment or a return if the business makes money.

There are lots of things to consider when giving up equity. They're beyond the scope of this article, but they include decision-making and voting rights, dilution, valuation and exit methods.

Advantages and disadvantages

Sources of equity financing

The main sources of equity finance for small business include:

  • Personal finances/bootstrapping - most small businesses begin this way.
  • Venture capital - businesses that specialise in making investments in companies in whom they see potential
  • Private investors/angel investors - like VC, but individuals rather than firms
  • Family & friends - taking cash from people you know in exchange for part ownership.
  • Crowdfunding or equity crowdfunding - a recent method of fundraising which gives the public early or exclusive access to a product or service in exchange for up-front funds. Equity crowdfunding involves offering shares for funds at an early stage.
  • Government - in certain circumstances, a government grant may be available for small businesses.
  • IPO (or initial public offering) - to float your company on a stock exchange and sell shares to the public

How to choose the business financing option that’s best for you

Business financing can take many forms. With so many options, it’s important to know what works best for your business and how to choose the right one.

You may be looking for a loan or line of credit, equipment financing, or even an alternative financing option. Here are some things to keep in mind as you look for the best business financing option for your company:

How to choose between a loan or line of credit

When considering the type of business financing you need, consider whether you need access to cash immediately or if it will be used over time. A loan is a good option if you need money fast. A line of credit may be better if you don’t need immediate access or if it will take time to pay off the loan.

How to choose between a fixed vs variable rate

When choosing between fixed and variable rates, consider how long your business plan is for and how much risk you can handle with your finances. Fixed rates are predictable and stable; variable rates fluctuate depending on market conditions like inflation and interest rates. The longer your term on a fixed rate loan, the more predictable it will be — but also the higher it will be up front.

Disclaimer: always refer to professional advice. The information presented here is purely indicative and not intended as advice. Always consult a legal or finance professional.

Discover how Apositive can help your business grow

Our consultants have extensive experience assisting the growth of hundreds of businesses like yours. Get in touch with us today and see how we can make a positive difference.