Explain The Many Different Ways A Small Business Can Get Funding



Explain The Many Different Ways A Small Business Can Get Funding

Getting access to funding can be quite challenging for a business. More so if you are a small business owner. When most small businesses start, they usually rely on their savings and borrow money from friends or family. Only when they are in business for a while or large enough, do they consider other means of financing to meet their expenses or further expand their business.

Even when a small business in operation for a long time, they often find that their options for obtaining business finance are limited. Most traditional banks or financial institutions require a lot of paperwork and even some form of collateral. Due to this, small business owners who may not be experts at handling finances get intimidated and give up. Many small business owners are not even aware of the vast choices they have from funding options. The most popular ones these days are the alternative form of lending online, which a lot of businesses are taking advantage of.

Many business owners take a variety of different loans from different sources, thus spreading their risks. Taking different forms of financing to meet different purposes also helps to meet different requirements. For example, small business owners can take a lease for equipment purchase, a line of credit for their working capital needs, and hire an investment advisor for their savings and investment. This way they can make use of commercial banks for their daily financial needs, and investment banking or capital markets for other requirements.

The Financial Market Place / Industry

To benefit fully from the various options that a small business may have, they must have the knowledge and know-how of how these markets or these institutions work. Here is some brief information about the various sources of finance available to business owners and a summary of how they work so that businesses can make the best use of them.

Investment Banks

Investment banking is a segment of the banking operations that helps organizations and individuals raise capital and providing financial consultancy services. They also act as intermediaries between investors and security issuers which support new companies in going public. They can buy shares that are available at an estimated price through experts and then sell them to the public. Or they sell those shares on behalf of the issuer and charge a small commission on every share. It is a complex financial structure, but it serves many different entities and purposes. It provides financial services such as trading securities, proprietary trading, mergers, acquisitions advisory, and leveraged finance (lending money to firms for the purchase of assets and for settling acquisitions). They also help companies restructure their business models to make them more efficient and are also involved in the issuance of IPO’s (Initial Public Offering) when firms go public. Examples of the top investment banks are JPMorgan Chase (JPM), Morgan Stanley (MS), Goldman Sachs (GS), Bank of America (BAC), and Citigroup (C). Their clients are generally other corporations, financial institutions, pension funds, hedge funds, governments, and more. They may even have retail operations for a few of their small individual customers.

Functions and Features of Investment Bank

They act as intermediaries between the investors and the issuers. Additionally, they provide financial, strategic, and valuation advisory services. They help to raise capital through securities, debt, and private equity. They advise companies in mergers and acquisitions as well as provide unique products and services to both, governments and corporate clients. In a nutshell, investment banks are involved in:

  • Issuing IPO’s
  • Investment Management
  • Mergers and Acquisitions
  • Structuring of Derivatives
  • Merchant Banking
  • Risk Management

Commercial Banks

The primary purpose of commercial banks is to provide checking accounts, take deposits and provide personal, business and mortgage accounts. They also offer other banking products like CDs (certificates of deposit) and different types of savings accounts to small businesses and individuals. Most people have a commercial banking account, rather than an investment banking account. Commercial banks make money through the loans they provide – and by the interest, they charge on them. The banks get cash through customers’ savings and checking accounts, through which they make loans. Commercial banks are regulated by the government which means the customer’s money is safe. The interest that the customers earn on the accounts is quite less as compared to other investment spheres like stocks, mutual funds, etc.

Features of a Commercial Bank

They are generally involved in fulfilling the short-term and medium-term financial requirements of individuals and small business owners. They are not engaged in long-term credit, which means the assets should be liquid. The funds of commercial banks belong to the general public and may be withdrawn at short notice. That is why, commercial banks prefer to provide short-term lending, which is backed by marketable securities or tangible assets. When commercial banks lend to industries or business owners, they consider factors like the size and the nature of the business, its profitability, the financial status of the company, and its ability to repay the loan amount. The commercial banks can be:

  • Public Sector Banks
  • Private Sector Banks
  • Foreign Banks

Primary functions of Commercial Banks

  • Accepting deposits (demand and time)
  • Advancing loans
  • Collecting checks, incomes
  • Paying expenses
  • Providing locker/safe deposit facilities
  • Issuing traveler’s checks
  • Transfer of funds
  • Dealing in Foreign exchange
  • Electronic banking

Investment Banking has Entered Commercial Lending

As mentioned already, investment banks deal with corporations, providing them expert financial services. On the other hand, commercial banking is involved with individual customers and small businesses, providing them lending and other banking products. In the last few years, however, investment banks have started competing with commercial banks by providing capital to alternative online lenders. Alternative lenders are now competing with commercial banking by providing loan facilities to small businesses. Their competitive edge over commercial banks is that they are much faster than banks and also cater to subprime borrowers.

Investment banks have realized that small business lending is growing and is already a $10 billion industry. So they have decided to lend to the small business owners as well through online lenders, without having to deal with the additional regulations which commercial banks have to keep in mind. A study recently conducted by the Harvard Business School has estimated that online lenders have more than $10 billion outstanding loans. This figure is seventy times less than the total loans which are being collectively held by the commercial banks.

Growth in Online Lending

There has been a growth in online credit with a more than 80% increase over each year. Former US Treasury Secretary Larry Summers has given the estimate that the alternative lenders can now issue up to 75% of small business loans.

What Other Financing Options Does A Small Business Have?

Apart from the traditional sources of funds from banks, financial institutions, and online lenders, small business owners also have another source: private investors. While many financial institutions may not be willing to lend to a small business, private investors come forward and provide funds to risky companies in which they can see some potential. Many private investors are especially inclined to invest in startup companies. Mentioned below are the different private investors a business may turn to.

Private Investors

What are Private Investors

It is a company or a person who invests their own money in another company, to make that company succeeds and then gets a return on their investment. Private investors can be companies as well, which only focus on the return of their investments, such as venture capitalists and angel investors. Such types of investors are not traditional banks.

What is the Difference Between Private and Professional Investor?

A private investor is a natural person. This means he or she is not a partnership or a corporation, proprietorship or any other form of business entity and uninvolved in any investment services.

A professional investor, on the other hand, can be a partnership, a corporation, proprietorship or any other form of entity and an expert user, even if they are not part of investment services. They are recognized by the SEC (Securities and Exchange Commission) or other authorities to provide investment services.

Types of Private Investors

Friends and Family

They are often the only or the primary kind of private investors which a small business turns to for their lending options. Friends and family are a great form of support in terms of finances for seed funding and startup capital. They already have personal involvement with the founders of the small business, which they would otherwise need to build with other private investors.

Angel Investors

Angel investors are wealthy people who invest their capital in new businesses, particularly, startup companies in their early stages. Angel investors sometimes pool their money in with other angel investors, forming a pool of investment. To explain what an angel investor is, it is someone who has a net worth of more than $1 million or earns over and above $200,000 in a year. These angel investors are using their own funds and not invested capital. They may be high net worth individuals, but they are using the money from their own pockets. The amount they invest in a company is not much and ranges from a few thousand to a million dollars. Angel investors are sometimes the only accessible form of funding that a business may have in the early stages for their capital requirement, and as such, they are an integral part of the equity fundraising system. There is no particular limit to how much an angel investor can invest, but typically it may be as little as $5,000 and can go as high as $5,000,000. The average amount of the angel investor is generally around $500,000.

High Net Worth Individual (HNWI)

There is a classification that is used by the financial services industry to denote a family or an individual as a High Net Worth Individual. This is someone who has liquid assets that are over and above a certain amount. There is, no particular figure of how rich or wealthy an individual must be to fit in this category, however. The high net worth is generally quoted in the form of liquid assets which are of a specific figure. The total amount is different for different financial institutions, and it can vary between people with a net wealth of around six to seven or more figures.

Venture Capitalist

Venture capitalists are regular people, who take risks on opportunities they find fruitful, similar to how an investor would in the stock market. They are quite different from regular people though since they work for venture capitalist firms. They are not investing their own money, unlike angel investors. Instead, they use the money of the venture capital firm that they work for. They work hard to make sure they earn from their investment, but quite often this is not the case. A venture capitalist’s job is to find a few investments (which is less than twelve a year on an average) which they have to make over the period of seven to ten years. Venture capitalists have to consider thousands of deals in a year but only have to choose the best ones to pursue.

How do Venture Capitalists Work?

A venture capitalist firm is usually found by a few partners who have raised quite a large amount of funds from a few LP (limited partners) to invest on their behalf. The Limited Partners (LP) are generally large corporations or institutions, such as a university or a teacher’s retirement system run by the state. The state itself may be using venture capitalists to generate a significant return on their funds. Venture capitalists have a period of around seven to ten years in which they have to make a substantial return on their investment, which means they must invest in those deals which can generate significant returns. The large returns not only provide profit for the fund but also help to cover the losses of any other failure that high-risk investments may have caused.

Venture capitalists usually invest in only a few deals, even though they have large sums of money. It is quite common to find that a venture capitalist firm may invest a total of $100 million on less than 30 investments over the life of the fund, which is why they are very choosy and selective when it comes to deciding which deals they will place their bets on.

Venture capitalists generally favor industries that provide a high return, such as the technology sector, as opposed to other companies like the landscaping business, which will not offer a very high yield.

Private Equity Firm

Unlike other private investors who are mostly engaged with startup capital, the Private Equity Firms are involved with growth capital. Private Equity is generally used for companies which already grown to a specific size and want to grow further or use an exit strategy, which may not be available to them via traditional means of financing. If you are a small business in the early stages, or even with just a business idea, then you are probably a bit too early for Private Equity Firms. Most Private Equity Firms are on the lookout for companies that are in a much later stage and require large sums of money (around $5 million or more) along with some sort of asset that they can leverage.

How do Private Equity Firms work?

They usually pool in money from their LP (limited partners) who may be insurance companies, pension funds, or other high net worth individuals. The reason why they invest in Private Equity Firms is so that they can have a group of managers who can seek out high-return investments for them. The focus of the Private Equity Firm, in turn, is to buy out a company that they can either sell, IPO, or generate cash flow. They are usually betting on the fact that the company they are seeking is worth more in the future than it is today.

Business Loan Brokers and Lenders

What is the Difference Between the Two?

These days, business owners have more options for getting financed than ever before. The best part is that banks are not the only option a business has to turn to. Owners can now seek funding from a variety of different alternate lending sources. Most small business owners use the services of business loan brokers instead of turning to a lender directly.

What do business loan brokers do?

Business loan brokers manage money. Initially, business loan brokers were restricted to Wall Street, but now things have changed. Business loan brokers are easily found in every industry, from small business loans to mortgages. A small business owner pays a broker to find them a lender who can provide funds to the business. This means that the brokers are simply the middlemen. The brokers generally find the small companies a loan with a lower rate of interest than the loans they have found on their own. So the business owner has to pay the broker a fee that they charge for their services and they have to repay the loan as well.

Why go for Direct Business Lending?

If a small business needs a loan, this means they probably would not want to pay anything extra. Business loan brokers usually take some time in getting credit for the business. They have to look at different options and present them to the company who may or may not go with them. Sometimes these options are not viable, especially when the business needs funding fast. In such a case, the best thing for a company to do is to go for direct business lending. This way, they do not have to deal with any brokers or pay anything additional in the form of hidden fees, or waste time considering different options. Instead, you can get the loan that you want and get back to running your business. There are plenty of funding options available to small businesses these days, especially the alternative finance sources online, which provide loans in less than 24 hours!

Business Loan Brokers

Why Use A Business Loan Broker?

Sometimes it may be hard for a small business to get a loan. They have to analyze the needs and the requirements of their business operations and also look for a lender with whom they can negotiate a deal. The lender should be able to understand their terms of financing. Business loan brokers have more knowledge and know-how of lenders in the market and as such, may save the business a great deal of time and money, along with other benefits such as:

  • The Best Rate
    The best brokers will submit the business’s application to various lenders so that they can get the best possible price for the loan. The company may have just gone to one lender and might not have known if there were better options available.
  • Explore Alternative Options
    A broker can help a business get a loan from elsewhere, such as an alternative financer if the loan for the small business gets rejected from one place.
  • It is their Job
    Most of the reputable brokers have relationships with an extensive network of lenders. This way they can get some good deals, all of which depend upon having the right contacts.
  • Knowledge of the Market
    A broker has extensive experience with loans and may be able to provide business additional advice and information regarding the best loan option for them. They know more about debt service ratios and personal credit options more than a business might.

What to choose – Business Loan Brokers or Direct Lending?

There are many factors which a business may consider. It is not always easy to find the right business loan broker who can help them get a good deal. They also need to consider the urgency of the loan and whether they have enough time to wait for the broker’s deal. Moreover, they also need to consider things like the cost of the loan, the downside of the loan, and more.

Business Brokers

When it comes to intermediaries and agents for business, we must also explain what business brokers are. A business broker can be referred to as a trained professional or a company that helps people to buy and sell a business. Most business brokers have a license, but it depends on the state regulations as well. Brokers give an estimate of the value of the business; they do the advertising and also conduct interviews with potential buyers who may be interested in the purchase of the business.

A business broker may be specialized in specific areas. They may be an expert in selling companies of a particular size, for example, those with annual sales of $5 billion or more. They may specialize in selling businesses that have some unique features such as a highly regulated business, etc. The job of a business broker can be considered similar to the job of a real estate agent, and the only difference is that the business broker is helping you to buy or sell a business as opposed to property.

What is the job of a Business Broker?

Business brokers play a crucial role in providing advice, guidance, and other resources which are necessary for the transaction to happen. Most business brokers have years of experience in this field and so, they can provide the buyers or sellers valuable business information and expert advice that can save them both time and money. Brokers are also well connected with attorneys, accountants, and finance professionals who help them in facilitating the sale or purchase. Even before a business is bought, a broker provides the buyer valuable information regarding the business through which the buyer can focus on what he does the best: running the business while the broker manages the transaction. The brokers charge their fee in the form of commission, which is usually 10% of the sale price of the business and is generally paid by the seller.

Real Estate Brokers

There is a difference between a real estate agent and a real estate broker. Real estate brokers are agents who possess a license, but not all agents are brokers. The brokers assume the responsibility for the agents and the transactions are managed by their brokerage on their behalf. The brokerage provides consultation, oversight, and direction to make sure that the transactions are handled according to the law in the best possible way. The main difference between a real estate agent and a broker is that a broker has passed their license exam and can own a real estate company and can hire people and manage real estate agents. Real estate agents have to work under a designated broker.

Difference Between Real Estate Broker and Business Brokers

Real estate brokers are different than business brokers in quite a few ways. Real estate brokers and business brokers both require separate licenses to operate. In many states, such as in North Carolina, while a real estate broker needs to pass a 75 hours course, there is no such requirement for business brokers who plan to sell businesses. This means that anyone can be a business broker in such states and does not need a license to do so. And while real estate brokers can become business brokers, business brokers cannot do the opposite.

Real estate brokers are more regulated as compared to business brokers, and real estate transactions are formalized much easier since there are public records available about the property deeds. When it comes to business deals, there is more of a risk involved, and the buyer has to verify whether the business they are buying is transferrable and if it really makes the money the seller is claiming it does. The sale of the real estate, on the other hand, does not involve the employees, goodwill, or earnings while in the sale and purchase of a business these are involved.

Who to choose when selling your business?

It depends on whether the business that you are selling also includes real estate or not. There are generally more options for an exit for those business owners who also own the property. This way they can decide whether they want to use the services of a real estate broker, a business broker, or a real estate broker who is also a business broker. It depends on their experience, know-how and the knowledge that they have about the deals and the credentials as trust and professionalism are crucial for such deals.

Lease Brokers

A leasing broker can be defined as an intermediary who is between a customer, the funder, and business (which depends upon what is being leased). A customer usually leases an asset which may be equipment or an automobile, land, building, machinery, etc. The lease is for a certain period of time and the customer has to pay lease payments for that specified amount of time.

What is the job of a Lease Broker?

A broker develops relationships with the manufacturers who manufacture the machinery or equipment and with the lenders or banks. Then they find business owners who are in need of equipment but are unable to purchase it with the cash available with them. Or they find businesses that only require the assets for a particular period of time. The manufacturers are able to benefit by getting more money from a single piece of an asset over the lifetime of the lease, as compared to if they had sold it for a lump sum. If the customer is unable to arrange for the money to apply for the lease, this is where the financing company of the leasing broker comes in. The lease broker puts the lender in contact with the business that is looking for a lease.

A leasing broker is generally specialized in specific industries, and they become experts in their fields. For example, there can be a lease broker for automobiles, for certain types of machinery or heavy equipment. Such lease brokers become experts and are able to provide the customer with professional advice and guidance along with great deals from more than one possible manufacturer. They also arrange for the financing of the lease if the business cannot do it on its own.

Why use a Lease Broker?

Most lease brokers do not have any particular affiliations with any specific manufacturer. They also represent more than one funder as well. This means that they are not representing any specific party and their advice is impartial. This way, they can give a customer multiple options along with competitive prices. They can build a long-term relationship with their customers by providing them information and support that can reduce the customer’s liability and improve their time management.

Savings and Investments

A business owner also has to consider many options for saving and investment needs, apart from the many sources of financing that his business might have. This includes using the expert services of investment advisors or financial planners or investing their funds in the capital market.

Capital Markets

When there is a mention of funding, it is not complete unless the capital markets are involved. It is where the savings and investments are channeled between those who have the capital and those who need the capital. This includes institutional and retail investors who are the entities who have the capital, while those who need the capital are governments, businesses, and individuals.

What Consists of Capital Markets

Capital markets are divided into primary and secondary markets. The stock exchange and the bond market are the most common type of capital markets. The capital markets help in improving the efficiency of transactions. They are able to bring together those who want the capital and those who need the capital to provide a place where such exchanges can take place. It is in these markets that equities like stocks and debt securities like bonds are traded. Capital markets are an integral part of any functioning economy.

Capital Markets may also refer in the broad sense to other financial assets as well.

  • Corporate Finance
    When it comes to Corporate finance, the capital markets are where there is capital that is investable, available for non-financial companies, which includes external funds. This includes common equity, preferred equity, and public bonds.
  • Financial Services
    Those financial companies that are involved in the private markets, as opposed to public markets also make up the capital market. This includes private equity, investment banks, and venture capitalist firms.
  • Public Markets
    These are operated by an exchange that is regulated, and capital markets here may refer to the equity markets in contrast to fixed income, bond, debt, commodity markets, and derivatives.
  • Other Forms
    Capital markets may also refer to the investments through which short-term gains take place, for the assets which are held for less than a year and which are taxed as income.

Investment Advisors

An investment advisor can be a group or a person who can make investment recommendations or perform a security analysis for their clients, for a fee. This can be done through direct management or the customer’s assets, or it can also be done through written publications. They need to be registered with the SEC (Securities and Exchange Commission). When registered, they are known as RIA, which stands for Registered Investment Advisor. They may also be referred to only as a financial or investment advisor. They manage the money for their clients and select assets like bonds, stocks, and mutual funds. They then monitor these assets for the client, keeping in mind the client’s investment goals. Investment advisors usually have discretionary powers over the account of their clients, which means they have the general authorization to trade for them.

What do they do?

Some investment advisors manage all aspects of their client’s financial life by giving them a complete financial or investment plan, which is sometimes referred to as ‘wealth management.

Why use an Investment Advisor

Investment Advisors are suitable for those who require some expert or professional advice on how to invest in stocks and bonds or other assets and securities. The investment advisor will take care of the goals of their clients, their risk appetite, and the time horizon and use their expertise to suggest and manage the best form of investments for their clients.

Are Investment Advisors the same as Financial Planners?

While most financial planners are also investment advisors, but not all investment advisers are financial planners. Financial planners look at every aspect of their client’s financial life, which includes taxes, investments, savings, retirement, and real estate. Then they develop a plan through which all the client’s financial goals can be achieved. They may be able to recommend their client’s certain products to choose from, which may not always include securities. They may not have discretionary power over the account of their clients and may not necessarily be regulated.