While there’s something to be said for bootstrapping a business, leveraging debt to launch or scale can be a game changer if handled properly.
The key to success here is twofold.
First, you need to be responsible with debt because it can quickly spiral out of control—especially in a soft economy, so how you use that debt is critical. Second, you need to understand the options available for funding because they each come with different pros and cons and the wrong approach can cripple or destroy your business..
So in this article, I’m going to outline the three types of business funding, how they work, and their pros and cons, so you can choose the option that’s best for your situation.
Equity funding
When it comes to raising capital for a business, equity funding is the strategy we typically hear the most about. That’s not because it’s the best. In my opinion, it’s just because it’s more exciting. Think about all of the funding stories that get the most attention on social media, from stages, and in the media—they all go something like this, “XYZ company just raised $5 million in capital to scale.”
It’s flashy. It’s a status symbol. And it’s an opportunity to create a bigger impact.
It’s also giving away a big part of your life’s work.
That’s because that capital comes with conditions. And the biggest one is giving up an equity stake in your company—often a majority stake, which means you may no longer control your own company.
I’m not saying this strategy can never be a good one, just that you need to be fully aware of the drawbacks and have excellent legal counsel. I promise your lender will. The terms of the agreement will make or break your company because private equity is brutal.
It’s also a lot tougher to secure equity funding because ideas are a dime a dozen so you need to build a successful business before investors will even consider lending you any capital. You’ll need a proven business model, a track record of growth, and something that gives you a unique competitive advantage. That might mean proprietary technology, a prominent partner, or key clients with a lengthy contractual agreement.
Traditional debt funding
Business loans are the next most common strategy, and for some businesses, this can be a highly effective option.
But like any other strategy, there are pros and cons. Unlike equity funding, you won’t be asked to give up an ownership stake in your business, but you will have to sign a personal guarantee. This means that even if your business fails, you’ll still have to repay the debt, and if you fail to do that, the lender will come after you personally.
If that happens, you could be forced to liquidate personal assets, which may mean suffering a tax liability, and your personal credit will take a substantial hit making it harder to get credit from that point on.
When it comes to finding lenders, you have a lot of options. You can go to big banks, like Wells Fargo, Bank of America, or Citigroup, which are able to lend larger amounts, but their underwriting guidelines are incredibly stringent. Credit unions and community banks are another option, and while they tend to be more flexible in underwriting, they typically lend smaller amounts.
Regardless of which lender you choose, you need to be prepared for extensive paperwork and a fairly long timeline.
It’s worth noting there is a third option, but this market is far more fragmented. There are companies that will lend capital based on your revenue, and they’re able to do so quickly and with very little paperwork because they have direct access to your transactions. Intuit, the company that owns Quickbooks is one example, and several merchant accounts providers offer this as well.
Business credit card funding
I personally prefer business credit cards because they offer the most flexibility, especially for newer and smaller companies. Surprisingly, this is a strategy that most people have never even heard of.
You can use business credit cards to pay for any legitimate expenses your business encounters with one exception—you can’t purchase anything related to the cannabis industry. That includes services, inventory, payroll, and even real estate. From a functional standpoint, it’s essentially no different than a loan being deposited into your bank account.
It’s worth noting that you will have to sign a personal guarantee, just like with a traditional loan, so you’re still on the hook for the debt even if your business fails.
When you decide to seek funding using this strategy, you can either hire a firm to walk you through the process, or you can do it yourself, which is certainly something any business owner can do themselves. The only difference is that if you do it yourself, it will require more work, it will probably take longer, and the credit limits you negotiate will be lower. On the other hand, you will save some upfront costs.
And compliance is critical because doing it wrong can lead to getting both your business credit cards and the merchant account that processes the transaction closed permanently. When that happens, you’ll be flagged, making it difficult if not impossible to get new credit cards or merchant accounts in the future, and you could even face criminal charges.
You need to apply for business credit cards strategically, so if you’re doing it yourself, you’ll need to research the business credit cards that are available from various lenders first. This is crucial because there could be hundreds of options at any given time, and they change frequently. To put this into perspective, we have a team of full time employees whose only job is to keep track of the options that are available at any given time from all providers of business cards in the U.S.
Next, you’ll start using your new cards to begin building your business credit profile. Keep in mind that business credit works differently than personal credit, so frequently maxing your cards out and paying them off actually improves your score here.
And finally, you’ll renegotiate for higher limits and merge any credit cards held with the same lender every quarter or so.
As you build a history of responsibly managing your debt, your business credit profile will become stronger, enabling you to get access to even more credit. It will also make it easier to get traditional loans, and on better terms, and could even help you get better terms on equity funding as well.
Business funding can be a game changer is handled responsibly
Contrary to what Dave Ramsey preaches, debt is not dumb—but only if you manage it responsibly.
When leveraged strategically, debt can help you to make life changing moves in your business, while it can cripple or destroy your business when used improperly. And the line between the two is surprisingly thin. But in a soft economy, business credit can help you capitalize on key opportunities that rarely arise in a strong economy.
So as Eminem famously said in his 2002 hit, Lose Yourself, “You only get one shot, do not miss your chance to blow, This opportunity comes once in a lifetime, yo.”
You need to be ready to strike when opportunity presents itself, and having access to business credit before you need it is key.