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Capital sources: Types of financing

Small Business BasicsTwo types of financing surface in any discussion about finding sources of money: debt financing and equity financing.

The easiest way to raise money is through debt financing, or loans. Commercial lenders such as banks and finance companies tend to be the biggest source of debt financing. Through debt financing, the borrower is able to get funding and maintain control of the business. Lending terms are outlined in advance, and usually include a payback schedule and interest rates.

Equity financing means selling a stake in the business for money. Basically, the business owner gives up a share of the profits to the investor, and possibly some control of operations. Investors speculate that the business will succeed and that their shares will rise in value. When you think of equity financing, you can think of the stock market, where company shares are bought and sold every day by businesses hoping to raise money.

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You might also want to consider debenture. It is a type of loan, really a note, that the business owner gives the lender in exchange for money. Terms can be less stringent than commercial loans in respect to payback schedules as it is an agreement between the company and the investor. To make the loan terms more attractive for the lender, you can offer convertible debentures, wherein the loan can later be exchanged for equity, or stock, in the business.

Whether you hope to obtain financing from your in-laws or a full-fledged commercial lender, you'll have to answer certain questions. Most will be addressed in your business plan and loan proposal, but be prepared to face the questions on a loan application, as well.


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