The common types of funding for business are debt funding and equity funding
Types of funding for business
The common types of funding for business are debt funding and equity funding.
Debt financing
Debt financing occurs when a company raises funds by borrowing cash from a lender at a fixed interest rate and with a preestablished maturity date. When the maturity date is due, the business must pay back the principal and the interest earned. Sources of debt financing include bank loans, trade credit, and borrowing from relatives and friends.
Equity financing
Equity financing involves raising of funds needed to operate the business by giving up a portion of the business ownership. As a result, the investor in equity investment is allowed to share in the company’s returns. Equity financing include angel investors, venture capital, personal savings, and the stock market.
Lease financing
Lease financing is another type of funding for a business is in which the asset owner offers the company the right to use the asset against some periodical payments. In such a case, the company becomes the lessee while the asset owner the lessor.
Advantages of debt financing
Debt funding is advantageous for various reasons, including easier planning, higher freedom and flexibility, low-interest rates, reduced taxes, and retained control. Debt financing enables business owners to plan faster. Getting to know the period and the amount to be paid back allows the business owners to make their financial plans and budgeting easily. Likewise, debt financing guarantees retained control of the company as it does not make the business owner give up on the company’s ownership. The business is just obliged to pay back the debt at the end of the given duration. Similarly, debt financing has low-interest rates, making them more comfortable for companies to pay back. Additionally, with debt financing, the business becomes more flexible and has greater freedom as it is only obligated to the lender within the repayment period.
Disadvantages of debt financing
Despite the attributed benefits of debt financing, it has some limitations, which include; the debt must be repaid, it affects the company’s credit rating, and has high rates. Debt financing negatively affects a firm’s credit rating. Any loan that a company takes is noted on the credit rating making the firm’s credit score drop. Another limitation of debt financing is that the debt must be repaid as per the terms of the agreement, even if business performance drops. Therefore, the businesses with cash flow problems may have a lot of challenges in repaying the interest plus the principal.
Advantages of lease financing
Lease funding is beneficial to the business because it uses capital goods to avoid spending more funds on acquiring assets. Similarly, the company can enjoy tax benefits since lease payments can be deducted like a business expense. Also, leasing is cheaper as compared to other funding types. The leasing company is equally entitled to technical support from the lessor regarding the asset.
Disadvantages of lease financing
Lease funding is disadvantageous to the business because, at the end of the lease agreement, the business will not have ownership of the leased asset unless the company buys them. Lease financing can prove expensive, mainly because the lessee must pay lease rental as well.
Advantages of equity financing
With equity financing, the company is at less risk since it has no fixed monthly loan payments to pay. It also sustains cash flow for the business since it does not take funds out of the firm like it is the case with debt financing. Furthermore, equity financing is crucial in financing the growth of the companies with credit challenges.
Disadvantages of equity financing
With equity financing, the business owner losses control of the business as he/she gives up some control of the firm to the investors. Equity financing also has a high potential for conflict as partners might not always agree on decision making. Besides, with equity financing, the business owner has to share profits with the investors, and the funds paid to individual equity partners could be higher than the interest charged on debt financing.
The best funding for Hamburger Eatery
The best funding for Hamburger Eatery would be debt financing. It would enable the business owner to retain control of the business while also enjoying other benefits of debt financing, such as low-interest rates on loans, and more freedom and flexibility for the company.
Major costs that will have to be covered before the business generate any profit
Before generating any profit, the business owner will have to cover major start-up costs like research expenses, borrowing costs, employee expenses, advertising costs, and the business plan. For instance, the business will incur expenses in hiring market research organizations to assist in the evaluation process. Also, the company will have to incur the costs associated with the borrowing of funds. Similarly, insurance, permit, and license fees will have to be covered before the business starts generating returns. Moreover, the company will cover the cash management through various methods. For example, regular monitoring of cash flow, leasing of assets instead of buying them to help save on the company’s finances, and cutting costs related to utilities, payroll, rent, and loan interests.