Types of business funding

Having a financing option is crucial to getting your business idea off the page and into the world. If you’re starting up a small business in New Zealand for the first time, you’re going to need access to some business funding.

There are several financing options available to you when you first launch your business, each with their own advantages and drawbacks.

Even if you choose one financing option to float your business in the first place, you may need a second injection of capital to grow your business. 

Let’s investigate the financing options on the table so you can make the best choice.

What are the 3 types of business funding?

There are generally considered to be three primary types of business funding. These are known as internal funding, debt finance, and equity finance. Each form of business funding will be appealing to different business owners for different reasons.

Internal funding

Internal funding is a financing option that’s only available to those who’ve worked to save a decent reserve of capital. 

Many people will studiously save for years with a business in mind. You might have originally saved for a house deposit but have instead decided to use it on a business idea. Maybe you’ve been fortunate enough to come into a sizable cash reserve. You may have sold a previous business for profit, or you could have pooled savings with a partner to launch your own business. 

Whatever the case may be, internal funding dictates that you have enough spare and unencumbered cash deposited, to fund the initial setup of your business venture.

Advantages

• The key advantage of internal funding is that you’re free from debt. 
• You won’t be paying unnecessary interest and you’ll be largely free from the risk of bankruptcy.
• It’ll be much easier to access loans later (if necessary) as you’ll be free from debt and have business assets and trading history on your side.
• You’ll maintain complete control over your operations, as the opinions and demands of investors or third parties are non-existent.

Disadvantages

• Amassing or saving large amounts of capital is a steep hill to climb and can be unattainable for many aspiring businesspeople.
• You’ll often forgo the possibility of personal purchases and investments, such as property or vehicles. 
• Your cash reserves will be depleted, meaning that timely cash injection or growth opportunities may have to be forfeited.

Debt finance

Debt finance is an extremely popular business financing option. In many cases, debt finance may very well be the only reasonable choice available to you.

Debt finance refers to the acquisition of a loan to fund your business venture. This borrowed capital may come in the guise of a bank loan, line of credit, small business loan, overdraft, credit card, or any other form of borrowing which creates a debt on your part.

Advantages

• The primary advantage of debt finance as a business funding option is its broad accessibility. 
• If you have a solid business plan and represent a reliable bet on the part of your creditor, you can have every chance of being approved for a form of debt financing.
• While collateral is an advantage for loan security and approval of larger loans, you can often receive smaller amounts of funding with very few assets.
• If you have other cash reserves, you can invest this in times of need or use it to pursue a growth opportunity.

Disadvantages

• Debt financing, as the name suggests, will place you in the manacles of debt and attract interest charges.
• If you default on your loan, or your business goes belly up, you’re left with a very costly responsibility to pay your loan back.
• There’s a very real threat of bankruptcy or financial ruin if things go awry.
• You may lose any assets you used to secure your loan to start a business.
• If your intended loan amount is large, you’ll find it difficult to be approved without assets as security.

Equity finance

Equity finance is another popular and varied avenue to fund your business dreams. Equity finance denotes the acquisition of third parties to fund the business on your behalf, in return for equity. 

Often known simply as ‘investment’, equity funding means that you’ll give up a portion of control and financial ownership of your business in exchange for funding.

There are many types of equity finance. Equity financing can mean you seek cash from:

• friends & family
• crowdfunding
• angel investors
• floating shares

Advantages

• You won’t require large amounts of personal capital.
• You’ll be able to sidestep debt and won’t have to jeopardise your own assets.
• You’ll often have the advantage of your investor’s knowledge, experience, and business contacts. Sometimes two heads are better than one.

Disadvantages

• In many cases, you’ll have to give up a portion of control over your business.
• You’ll have to pay out your investors, meaning less profit or equity for yourself.
• If you sourced funds from friends or family, you may negatively affect your personal relationships – especially in the event of business failure.
• You’ll need a very solid and dependable business proposal. This business plan will need to be very mature, with clear pathways to profit and clear-eyed consideration of risks.

Angel investors

Angel investors are considered a form of equity financing. Angel investors are often the most serious type of business investor. They’ll come with a keen eye for opportunity, a history of success, deep pockets, and a significant amount of experience and knowledge.

On the other side of the coin, finding, convincing and gaining investment from an angel investor is one of the most difficult types of business funding to secure. They’ll have strict requirements, need an outstanding proposal, seek a large stake, and could be actively involved in the running of the business.

Development grants

If you’re lucky enough to be in an industry which attracts development grants from the NZ Government, you may be able to minimise your reliance on the aforementioned business funding options.

Through partner institutions like Callaghan Innovation, you may be fortunate enough to receive a form of funding or assistance. Even if you don’t qualify for grants, you may be able to receive mentorship and training.

Check with the NZ Government, to see what’s out there for new small businesses and established businesses.

Business loans

If you choose the business funding route of debt financing, you’ll have a few options to play with.

Before you commit to a business loan, be sure you shop around and consider the pros and cons of the following types of debt financing:

• bank business loans
• short term business loans
• finance company loans
• business credit cards
• overdrafts

That concludes our NZ small business guide to types of business funding. Be sure you do your due diligence and familiarise yourself with the specifics and competing considerations of each financing option before you make a decision.