Starting a business is one thing. Making it financially stronger, more professional and capable of growing is another.
At some point, most business owners need money for something: buying equipment, hiring staff, developing a new product, opening a second location, investing in marketing, smoothing out a temporary cash-flow problem, or simply giving the business enough breathing room to take the next step.
This is where business finance can start to feel unnecessarily complicated.
You will encounter terms such as working capital, debt finance, equity, overdrafts, cash flow, interest rates, secured lending and business loans. You may also be presented with an impressive-looking spreadsheet by someone who seems to assume you already understand all of it.
Don’t panic.
The basic idea is actually quite simple:
You are deciding where money will come from, what it will cost, and what you are prepared to give up in return.
This article will help you understand your main options and, just as importantly, how to think about them.
First: Why Do You Need the Money?
Before looking for finance, get very clear about what the money is for.
This sounds obvious, but it is one of the most important questions you can ask.
There is a big difference between borrowing $50,000 to buy a machine that will generate additional revenue and borrowing $50,000 because the business is continually running out of cash.
The first might be an investment in growth.
The second might indicate that the underlying business model needs attention.
Ask yourself:
- What exactly will the money be used for?
- How much do I actually need?
- Is this a one-off expense or an ongoing requirement?
- Will the investment generate additional revenue or reduce costs?
- How quickly should I expect to see a return?
- How will the business repay the money?
- What happens if the expected growth doesn’t occur?
The last question is particularly important.
Good financial planning does not assume everything goes perfectly.
If you are borrowing money based on the assumption that sales will increase by 30%, consider what happens if they increase by only 10%.
The Three Broad Ways to Fund a Business
Most business funding falls into three broad categories:
- Your own money
- Borrowed money
- Other people’s investment
Each has advantages and disadvantages.
1. Your Own Money
This might include money you have put into the business personally, retained profits from the business, or cash generated from normal operations.
The obvious advantage is that you don’t have to pay interest to a bank or give away part of your company.
The disadvantage is that your own money is at risk.
There is also an opportunity cost. If you put $50,000 of your personal savings into the business, that is $50,000 you cannot use for a house deposit, investment, emergency fund or other purpose.
So “using your own money” is not actually free finance.
It simply means you are the financier.
2. Borrowed Money
This is known as debt finance.
You borrow money and agree to repay it, usually with interest, over an agreed period.
Common examples include:
- Business loans
- Overdrafts
- Equipment finance
- Asset finance
- Lines of credit
- Credit cards
- Property-backed lending
The attractive feature of debt is that you normally retain ownership of your business.
If you borrow $100,000, the lender doesn’t generally receive 20% of your company. They receive their loan repayments and interest.
The downside is equally obvious: the repayments don’t care whether you had a good month.
If your business makes $20,000 profit this month, you pay the loan.
If it makes $2,000, you still pay the loan.
3. Other People’s Investment
This is generally referred to as equity finance.
Instead of borrowing money, you bring an investor into the business in exchange for capital.
For example, an investor might put $200,000 into your company in exchange for 20% ownership.
There are no traditional loan repayments, which can make equity attractive for a growing business that needs to invest heavily before it becomes profitable.
But equity is not free money.
You have given away part of the business.
That means the investor may be entitled to part of future profits, may have voting rights, and may expect a say in important decisions.
If your company eventually becomes worth $10 million, the 20% you gave away could be worth $2 million.
That is why the question is not simply:
“Can I get the money?”
It is:
“What will this money ultimately cost me?”
Debt vs Equity: The Simple Version
Think of debt and equity like this:
Debt:
“Give me money now and I will give it back to you, plus interest.”
Equity:
“Give me money now and you can own part of what this business becomes.”
Neither is automatically better.
A stable, profitable business with predictable cash flow may be well suited to debt.
A young business with significant growth potential but unpredictable cash flow may be better suited to equity.
And sometimes the answer is a combination of both.
What Is Working Capital?
You will hear the term working capital constantly in business finance.
It sounds complicated. It isn’t.
In simple terms, working capital is the money your business needs to keep operating while it waits for its normal income to arrive.
Imagine you run a business that sells to other companies.
You purchase $20,000 of stock today.
You sell it to a customer next month.
The customer pays your invoice 60 days later.
You may have generated a healthy profit on the sale, but you still needed enough cash to survive the period between paying your supplier and receiving your customer’s money.
That gap is a cash-flow problem, not necessarily a profitability problem.
This distinction is crucial.
Profit is not the same thing as cash.
A business can be profitable on paper and still run out of money.
Cash Flow: The Number You Should Watch Closely
Your profit and loss statement tells you whether the business is profitable.
Your cash-flow position tells you whether you can actually pay your bills.
Both matter.
Suppose your business has:
- $100,000 in sales
- $70,000 in expenses
- $30,000 profit
That sounds excellent.
But what if customers have not yet paid $50,000 of those sales, while your suppliers require payment this week?
You may have a profitable business that is nevertheless struggling to pay its bills.
This is why growing businesses can sometimes experience a surprising problem:
Growth can consume cash.
You may need to purchase more stock, employ more people, increase marketing and pay suppliers before customers pay you.
Ironically, getting bigger can temporarily make your cash position worse.
How Much Should You Borrow?
This is where many first-time business owners make a mistake.
They calculate the amount they need today and borrow exactly that amount.
A better approach is to think about the entire funding requirement.
Suppose you need:
- $40,000 for equipment
- $10,000 for installation
- $5,000 for training
- $15,000 of additional working capital
Your actual funding requirement isn’t $40,000.
It is $70,000.
And you should also consider whether you need a sensible cash buffer.
Being forced to borrow again three months later because you underestimated your original requirement can be expensive and frustrating.
On the other hand, borrowing significantly more than you need creates unnecessary interest costs and temptation to spend.
The objective is not to borrow as much as possible.
It is to have enough appropriate funding for the job.
Match the Finance to the Asset
A useful rule is:
The longer the benefit lasts, the longer the finance can reasonably last.
For example, financing a piece of equipment that should generate value for five years with a very short-term loan could put unnecessary pressure on your cash flow.
Likewise, using a 10-year loan to fund a short-term cash-flow gap may be inappropriate.
Try to match the term of the finance with the useful life of what you are financing.
This is sometimes called matching funding to the asset or investment.
Don’t Automatically Choose the Lowest Interest Rate
Interest rates matter.
But they are not the only thing that matters.
When comparing finance options, look at the total cost and the conditions.
Consider:
- Interest rate
- Establishment fees
- Ongoing fees
- Early repayment fees
- Security requirements
- Loan term
- Repayment frequency
- Variable vs fixed interest
- Personal guarantees
- Other restrictions or covenants
A loan advertised at a lower interest rate may not necessarily be the cheapest or most suitable option once all of the costs and conditions are considered.
This is why you should compare the whole deal, not just the headline rate.
What Does “Secured” Mean?
A secured loan is backed by an asset.
For example, a lender might lend money against property, equipment or another asset.
If the borrower fails to repay the loan, the lender may have rights over that security.
An unsecured loan does not have the same specific asset backing it, although the lender may still require guarantees or other protections.
Generally, the more security a lender has, the more comfortable they may be with lending.
But from your perspective, security is important because you need to understand what is at risk.
Never sign a finance agreement without understanding exactly what you are guaranteeing.
Personal Guarantees: Read This Bit Carefully
This deserves special attention for small-business owners.
A lender may ask you to provide a personal guarantee for business borrowing.
In simple terms, you may be personally promising to repay the debt if the business cannot.
That means the distinction between “business debt” and “my personal financial risk” can become much less clear.
Never assume that because the loan is in the company’s name, you personally have no exposure.
If a lender asks for a personal guarantee, understand:
- What exactly are you guaranteeing?
- Is the guarantee unlimited?
- When does it end?
- What assets could potentially be exposed?
- Does the guarantee continue if the business changes ownership?
This is an area where getting professional legal and financial advice can be very worthwhile.
What Will a Bank Look At?
If you apply for business finance, the lender will generally want to understand whether you can repay the money.
They may look at things such as:
- Your revenue
- Profitability
- Cash flow
- Existing debts
- Assets
- Business history
- Industry
- Credit history
- Your business plan
- Your personal financial position
- The purpose of the loan
Don’t think of this as the bank being difficult.
The bank is asking a perfectly sensible question:
“If we give you this money, how are we going to get it back?”
You should be asking yourself exactly the same question.
Make Your Business “Finance Ready”
One of the best things you can do before approaching a lender is to get your financial information in order.
A professional business should be able to quickly produce:
- Recent financial statements
- Profit and loss reports
- Balance sheets
- Cash-flow information
- Business and personal tax information where relevant
- Details of existing debts
- Accounts receivable and payable information
- A clear explanation of what the new finance will fund
- Forecasts showing how the business will repay it
You don’t need to be an accountant.
But you should understand your own numbers.
If a lender asks, “What is your current gross margin?”, you shouldn’t have to stare at the ceiling and hope they change the subject.
Your Business Forecast Doesn’t Need to Be Perfect
A forecast is not a prediction of the future.
It is a model of what you think might happen.
Good forecasts make assumptions visible.
For example:
We expect sales to increase by 15% because we are adding two sales staff and increasing our marketing budget by $3,000 per month.
That is much more useful than:
Sales will increase by 15%.
The first statement explains why.
It also gives you something to monitor.
When preparing a forecast, create at least three scenarios:
Best case
Things go better than expected.
Expected case
Your most realistic estimate.
Worst case
Sales are lower, costs are higher, or something takes longer than planned.
The worst-case scenario isn’t designed to frighten you.
It is designed to answer a much more useful question:
“Can the business survive if things don’t go according to plan?”
Don’t Finance a Bad Business Model
This may be the most important advice in the entire article.
Finance is useful when it helps a sound business do something valuable.
It becomes dangerous when it is repeatedly used to disguise an underlying problem.
If your business consistently loses money, taking another loan may temporarily solve the cash shortage.
But it doesn’t necessarily solve the business problem.
Before borrowing, ask:
“If I had no access to finance, what would I need to change?”
The answer can be surprisingly revealing.
Perhaps prices are too low.
Perhaps customers take too long to pay.
Perhaps expenses are too high.
Perhaps you are carrying too much stock.
Perhaps you need to stop offering an unprofitable service.
Finance can buy you time.
It cannot, by itself, create a profitable business model.
A Professional Approach to Funding
As your business becomes more established, try to stop thinking about finance as something you desperately seek whenever cash gets tight.
Instead, make it part of your regular business planning.
Review:
- How much cash the business has
- How much cash it is likely to need
- Existing loans and repayment commitments
- Upcoming major purchases
- Expected changes in working capital
- Your borrowing capacity
- Your personal exposure
- Potential future funding requirements
This allows you to arrange finance before you desperately need it.
And that is a much stronger negotiating position.
The Funding Checklist
Before taking on new finance, make sure you can answer these questions:
- What exactly is the money for?
- How much do I actually need?
- What return will the investment generate?
- How will the finance be repaid?
- What happens if sales are lower than expected?
- What is the total cost of the finance?
- What security is required?
- Am I providing a personal guarantee?
- What happens if I want to repay the loan early?
- Have I compared more than one option?
- Have I considered whether I should use debt, equity, my own funds, or a combination?
- Have I checked that the business can comfortably handle the repayments?
If you cannot answer these questions, you probably aren’t ready to sign the finance agreement.
The Bottom Line
Business finance is not really about finding someone willing to give you money.
It is about choosing the right source of money for the right purpose at an acceptable cost and level of risk.
As a business owner, you don’t need to become a banking expert.
You do need to understand the fundamentals.
Know the difference between profit and cash.
Understand debt and equity.
Know what you are offering in return for finance.
Understand your repayment obligations.
And, above all, know what happens if things don’t go according to plan.
The goal isn’t to avoid borrowing.
The goal is to use finance deliberately—as a tool that helps a good business become stronger, rather than as a life raft for a business that hasn’t yet worked out how to swim.