Different Sources Of Business Finance

Any business is powered by a mix of two basic factors: labour or human resources, and capital or financial resources. The success of any enterprise in the long term is dependent on how these two factors of production or service are synced to create saleable products or services.

Needless to say, both are interdependent. Without the right workforce, a business cannot grow despite having capital. At the same time, getting the right human resources requires finance.

A business can be financed via three key modes, including one that is a mix of the first two:

1. Equity:

This is the capital chipped in by the owners or founders of the enterprise, however big or small. Over time, a business may raise additional equity capital from various investors, including the founders, as well as the public or other private investors like a venture capital firm or a private equity fund.

2. Debt:

Debt can come in various forms, but essentially, it is a loan which can be availed from a bank or non-banking finance corporation as well as other corporate investors. In fact, founders can also choose to back the company with additional resources in the form of debt by lending to the company instead of putting in more equity capital. The choice of the same would be dependent on various factors including the tax regime. Debt can be either in the form of a simple business loan or secured personal finance like a gold loan if the ticket size is low.

3. Convertible instruments:

These are instruments that sit in the middle of debt and equity. On the face of it, they are a debt product as they need to be repaid or redeemed, but in many cases they are used as additional leverage by private investors, as debtors have the first say on the assets of a business in case things do not go as desired. These can take the form of convertible debentures and similar securities.

Whether a company chooses to finance its operations and expansion plans via equity, debt or convertible instruments, can be based on various external factors.

These could be the cost of debt, availability of investors who want to pump in additional equity as shareholders, and taxability of various instruments when those securities are divested. There is a capital gains element involved, too.

On certain occasions when the cost of capital is high or liquidity in the credit system is low, getting a business loan can be tough and involve liabilities that exceed the repayment capacity of an enterprise given its cash flows. In such situations, it would do better to power the financial needs via equity capital.

On the other hand, when the interest rate cycle is at the lower end, it could be more prudent to take a business loan or debt to meet the needs.

Conclusion

Financial resources to run the operations of a business and for expansion can come from either equity or debt. Entrepreneurs and business owners should choose the most efficient route to raise financial resources after analyzing internal and external factors.