How to finance a business is one of the main concerns that
every new business person has to resolve. There are two main
ways of financing a business, equity financing and debt
financing.

The majority of start-up or small businesses use limited
equity financing. As with debt financing, additional equity
often comes from non-professional investors such as friends,
relatives or colleagues.

However, the most common source of professional equity funding
comes from venture capitalists. These are institutional risk
takers and may be groups of wealthy individuals or major financial
institutions. Most specialise in one or a few closely related
industries.

Venture capitalists are often seen as deep-pocketed financial
benefactors looking for start-ups in which to invest their money,
but they most often prefer three-to-five-year old companies with
the potential to become major regional or national concerns which
will return higher-than-average profits. Venture capitalists may
scrutinise thousands of potential investments each year but only
invest in a few.

Different venture capitalists have different approaches to
management of the business in which they invest. They generally
prefer to influence a business passively, but will react when a
business does not perform as expected and may insist on changes
in management or strategy. Relinquishing some of the decision-making
and some of the potential for profits are the main disadvantages
of equity financing.

Banks are one of the most common sources of debt financing. There
are many other sources for debt financing including: savings, loans
and commercial finance companies. It is also possible to ask for
funding from family members, friends or colleagues, especially when
the capital requirement is small.

Traditionally, banks have been the major source of small business
funding. Their principal role has been as a short-term lender
offering demand loans, seasonal lines of credit, and single-purpose
loans for machinery and equipment. Banks generally have been reluctant
to offer long-term loans to small firms.

In addition to equity considerations, lenders commonly require the
borrower's personal guarantees in case of default. This ensures that
the borrower has a sufficient personal interest at stake to give
paramount attention to the business. For most borrowers this is a
necessary evil.

Article written by John Mussi.