Empowering Entrepreneurs: Financing Options for Small and Mid-Sized Businesses

Posted by Jennifer M. Settles, Esq.Mar 19, 20240 Comments

Small Business Financing

Starting or growing a business takes financial resources that many businesses simply do not have on hand, so they have to consider other options. Finding the right way to finance the business is critical. Likewise, avoiding mistakes will help prevent delays and unanticipated negative consequences.

At the Law Office of Jennifer M. Settles, we help our clients at all stages of their  business life cycle. If you are a start-up, a small business looking to scale, or an already-established corporation, we will assist in the discovery and obtainment of the right financial support to propel your business and meet your goals. Contact us at (602) 617-3938 to schedule a free initial consultation and to learn more about all of our business law services.

Types of Business Financing

When starting or running a business, one of the most important questions is how you intend to capitalize it. If you don't have sufficient money yourself, then there are several other financing options you can consider. 

Debt Financing

Debt financing involves borrowing funds from a lender. These funds must be repaid with interest, usually via regular preset payments. Bank loans are a common example of debt financing. Debt financing options can be both short- and long-term, depending on the intended purpose for the use of the funds.  Additionally, loans can carry fixed or variable rates of interest.   

Some creditors require the debt to be secured by collateral. Collateral is an asset the creditor can take through foreclosure or other legal process in the event you fail to make repayments or otherwise default on the loan.  Collateral could consist of real property, personal property, the borrower's company itself, bank accounts, intellectual property, or other assets. 

Different sources of debt financing include:

  • Traditional or non-traditional banks, including loans, lines of credit, and credit cards
  • Commercial finance companies
  • Debt crowdfunding
  • Peer-to-peer lending
  • Bonds

Some government programs or agencies also offer assistance to small businesses seeking debt financing. For example, the Small Business Administration backs loans from certain banks, making it easier for small business owners to access capital, typically through an SBA 7(a) loan.    The US federal government's CDFI program, relating to economic growth in urban and rural low-income communities, is another example. 

Obtaining debt financing is often a long and costly process.  Lenders typically perform significant due diligence and underwriting before agreeing to make a loan, including performing a deep dive into a prospective borrower's financial statements, projections, business operations, prior tax returns, legal compliance matters, site visits, management biographical information and interviews, and more.  The process can also involve inspections and appraisals of the collateral, and the hiring of attorneys and other consultants, the costs for which (including both the lender's costs and the borrower's costs) are normally borne by the borrower.   Additional, lenders generally charge "points" or origination fees at loan closing, and the loan may also involve an interest  rate lock and rate lock deposit payable by the borrower.   

Accordingly, although there are many benefits to obtaining a commercial loan, it's important for a borrower to have realistic expectations when entering into a prospective loan transaction, in terms of cost and timing.    Assuming the borrower's business records are in order and the borrower timely submits all required information to the lender, obtaining a business loan typically involves an approximately 90-day due diligence process  (though it could be longer or shorter, depending in the situation).

The Law Office of Jennifer M. Settles regularly represents borrowers and lenders in commercial borrowing and lending transactions.  Call us today at (602) 617-3938 for a free initial consultation.    

Equity Financing

Equity financing involves an individual or company investing in your business in exchange for owning a percentage of the company. Unlike debt financing, investors are not repaid principal and interest.  Instead, they receive an equity interest in your company (ie, shares of stock, in the case of a corporation; and membership units, in the case of a limited liability company).  Depending on the terms of your investment agreement, an equity investor is entitled to dividends/distributions, a share in the tax attributes resulting from the business's operations, and may be entitled to a say in the governance and management of the company. 

Equity investments can come from:

  • Angel investors
  • Venture capitalists
  • Investment banks
  • Large corporations
  • Equity crowdfunding
  • Friends and family
  • Joint venture partners

Equity financing can be complex.   Contact the Law Office of Jennifer M. Settles for guidance on equity financing, by contacting (602) 617-3938, or visiting our web site at www.jsettleslaw.com.   We offer free initial consultations.   

Other Types of Financing

In addition to debt and equity financing, a range of federal and state government industry-specific grants are available to small businesses if they meet certain criteria. 

Leasing is another alternative to equity or debt financing. It is often available where your business requires a large piece of equipment or physical premises.   See our blog post for more information on real estate leasing.   

There are also variations on the financings described above, including preferred equities and convertible notes.   These types of arrangements can be viewed as a hybrid or combination of debt and equity features. 

Additionally, some businesses use a process of invoice factoring or sale of their accounts receivables as a means for obtaining  liquidity.     This can be a fast and convenient, albeit highly expensive, means for obtaining needed capital.   See our blog post for more information on accounts receivable factoring transactions.  

Many businesses structure or “stack” a combination of different types of financings. Each type of financing comes with potential advantages, disadvantages, and risks. For this reason, it is important to seek legal advice from a business attorney and financial advisor before choosing the most suitable approach for your business. 

Comparing the Advantages and Disadvantages of Business Financing

Advantages and disadvantages flow from both debt and equity financing. It is important to understand what to expect from each type of business financing. Likewise, keep in mind that each financing situation is unique, and so not all benefits or disadvantages will apply.

Debt Financing Pros

One advantage of debt financing (as compared to equity financing) is that it generally allows you to retain full ownership and control over your business. Unlike equity financing, you're not giving away any ownership in exchange for an investment. 

Debt financing involves an arms-length arrangement. The clear terms of the loan mean repayments are predictable and can be readily budgeted for. There is also a clear end date marking the termination of the commercial relationship between the parties. 

Another advantage is that the interest you pay on debt financing is tax deductible. 

Debt Financing Cons

With debt financing, you must use cash to pay repay loan and interest. This can limit your cash flow, which can be difficult when a business is first starting or is facing a cash-crunch.   

Debt financing also relies on a good credit rating and other due diligence by your lender.  If your business does not have strong credit and organized business records, it will be harder to obtain a loan.  Moreover, defaulting on a business loan has significant adverse consequences for your future credit rating. 

Debt financing can also be risky, especially if the lender requires security. The lender may want to secure your loan with a personal asset or assets of the business.  SBA lenders, for example, often require a second mortgage on the business owner's personal residence, a first priority lien on all of the business's assets, and even a life insurance policy on the business owner.

Equity Financing Pros

Equity financing offers a source of capital without going into debt or having to pay interest. The absence of new debt and interest payments should lead to increased cash flow, which can be reinvested in the business and not to debt repayment. 

Equity financing also gives you access to potentially large amounts of capital, which can be helpful for scaling a business quickly. Equity financing can be a good option if you are looking to develop a long-term business relationship with your investors, and they are interested in jointly building the business with you. 

Equity Financing Cons

As the business owner, you lose some ownership—and therefore control—over the business via equity financing. Investors may expect to have a say in how the business is run, which can lead to complicated and time-consuming arrangements relating to the day-to-day governance and decision-making for your company.  

Once you bring in equity investors, there is a heightened focus on governance and fiduciary duties of management.  Although good governance is always beneficial for business, compliance can be challenging.  

Equity financing also typically requires extra administration, such as regular reporting to investors, and potentially an audit by an outside accounting or CPA firm.   

Additionally, if your friends or family invest and the business does not succeed, failure can lead to strained personal relationships. 

How a Business Financing Attorney Can Help

A business lawyer can be a strategic partner in the growth of your business. Alongside other business law services, the Law Office of Jennifer M. Settles can help you secure financing and minimize risk.

  1. Planning.  We will review your business goals and financing options to determine the approach best aligned with your financial needs in the short- and long-term.
  2. Negotiating. We will gather supporting documents and negotiate your loan and investor documents.
  3. Closing. We will assist you in closing your deal deal, ensuring the best terms and mitigation of risk.

As implied by the various advantages and disadvantages of business financing, many complex factors must be considered. You want to make sure you adequately plan, properly apply, and timely secure the right funding. Doing so will help you avoid delays, minimize risk, and grow your business.

Contact a Business Financing Attorney Today 

You want your business on a strong financial footing, especially given the current volatility in the market. If you want to establish a solid foundation, contact the Law Office of Jennifer M. Settles today. Jennifer can be reached by either using the online form or calling us at (602) 617-3938 to schedule a free initial consultation. We look forward to helping you grow your business!