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Raising Funding for Your Small Business

written by: R. Elizabeth C. Kitchen•edited by: Jean Scheid•updated: 5/19/2011

Raising funding for your small business is the one of the first steps in entrepreneurship. There are many elements involved in this process, such as equity financing, debt financing, and more.

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    Business Ventures Need Funding

    When new entrepreneurs begin a new business venture, they will need funding. Some are lucky and have money at their disposal, but most do not and will need to seek out funding for their new business. There are different types of funding, also referred to as capital, available to new businesses. How a person obtains needed funding will depend on the type of funding. New entrepreneurs will need to determine which type, or types, of funding is right for them and their business.

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    Debt Versus Equity

    Just about every type of funding will fall under debt or equity. The main difference between these two is that debt must be paid back while equity does not. An equity investor, since they are not paid back, receives shares in the business instead of cash money. If the business goes under, an equity investor, can cash out their shares and receive a large return. Debt funding is typically repaid at a specific time, with interest.

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    Debt Financing

    Raising Funding for Your Small Business debt alexkalina sxc.hu Basic debt types include small business loans, such as bank loans, personal loans (such as those by friends and family), corporate bonds, and issued notes. These loans are offered at an agreed upon time period and interest rate. Convertible debts can later be converted to common stock, however, most are repaid in cash on a set date or schedule. The terms of the loan will determine whether the business owner pays interest during the loan term or interest plus the principle. Business assets are often used to secure debt instruments.

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    Equity Financing

    With equity financing, the investor will get stock instead of funds. This is the typical investment made by angel investors, venture capital funds, and other private equity funds. Since investors will not be repaid, they benefit from the businesses' growth and receive preferred or common stock.

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    Common Stock

    The most basic type of equity investment is common stock. This type of business funding represents an ownership in the business. It also includes an earnings interest. Holders will also be able to receive dividends. Those who hold common stock will be able to take part in the businesses' growth and if the business fails, stockholders are usually protected personally by the type of corporation they form. The advantage for business owners is that they have no obligation to pay back the invested amount unless specifically agreed upon. With successful businesses, the investors will be rewarded with the value of the businesses' growth.

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    Preferred Stock

    The second most common type of equity investment is preferred stock. Though, this type of business funding is considered equity, it can sometimes possess certain features that resemble debt which can make it attractive to some investors. It also reduces investment loss because it possesses rights over common stock. When it is issued, there is a reduction in risk of loss because investors are able to negotiate with the business about whether it will be non-voting or voting stock. Preferred stock offers a reduced risk and more flexibility, making it preferred over common stock. It is most desired when issued to venture capital funds.

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    How to Increase Your Chance of Obtaining Debt Funding

    Getting funding for a business can be difficult. However, there are a few things that an entrepreneur can do to increase their chances in obtaining funding for their business. If you only need a small amount, such as a few hundred to a few thousand, it is best to ask family and friends for a loan first. Use assets, such as a house, banked money, or a car, as collateral with a family or friend and make sure to sign a promissory note.

    If going through a bank for a loan is necessary, the same collateral can still be used. If you do not have collateral and your credit is poor, a co-signer will almost always be necessary. Friends and family can make great co-signers, but you will need to prove that the loan will be repaid or else they risk having to pay it back as well as the possibility of a decreased credit score. Banks want to give loans to those that are low risk. If they feel someone is a high risk, they are unlikely to give them a loan.

    In addition to a good credit history, an existing account with the bank in which you wish to obtain a loan, collateral, and possibly a co-signer, a business plan is also necessary. The more money that is needed the more thorough this business plan needs to be. The bank needs to feel that your new business has the ability to be successful so they feel comfortable that they will get their loan money back. Contacting the Small Business Administration will also help, often immensely. Banks will be able to help with $1,000.00 to $50,000.00 in debt funding, but those needing more than $25,000.00 may be better off seeking equity financing.

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    How to Increase Your Chance of Obtaining Equity Funding

    Raising Funding for Your Small Business equity jpsdq sxc.hu Obtaining equity funding tends to be far more sophisticated than debt funding. Those seeking $25,000.00 to $1,000,000.00 in equity funding are often much better off seeking a network of angel investors or an individual angel investor. They will be able to risk larger amounts of money in new business ventures that also have a high potential return.

    Getting funding will require the right advisors (accountants and lawyers) and a solid business plan and vision. You must also prove knowledge of the industry you are venturing into. Without these three elements obtaining equity funding will be quite difficult.