What type of funding should you seek when starting a business? Bank or investor funding isn’t right or wrong. Plenty of companies that have either type of funding has gone on to be successful. There is no right or wrong answer to whether or not one type of financing is better than the other. There are benefits and drawbacks in each form of funding to consider.
When you are starting a business, you have plenty of questions. The first thing that jumps to your mind is how much money you’ll need to start your business. Suppose you find that you do not have sufficient money. That’s worrisome. So, what should you do if you find yourself in that kind of position?
Thank Goodness, there are several ways to get money apart from funding. The funding option revolves around two choices – The first one is taking the loan. When you are taking a loan, you must repay the money plus interest within a certain amount of time. The second option is by investing. While inequity, the investor has to give a percentage of several shares to the business. At the same time, the return business gives capital to the investor. During this time, the investor hopes that the business grows with the expectation that the value of the share will rise. They are eventually gaining Return on investment.
When you make a business plan, be sure to know your audience well. Loan and investment are two different things in business. So, the process of money-making of both investor and lender is different. So, you need to customize your plans according to the targeted audience.
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Return on Investment (ROI)
If you look out for investor funding, then your prospective investors need to see your current valuation and an estimation of your future valuation concerning your business. Now you may think, how does a business estimate their current evaluation? It is done by keeping the account of the amount of investment requested and the percentage of ownership received in exchange for the investment. You need to keep in mind that when you are looking for an investment for a start-up business – the valuation of your business is based on the perception of potential investors. If the potential investor believes that the business will boom the market, then the valuation will increase. It happens vice-versa.
Certified business valuators are there in the market who can determine the accurate business valuation for you. Else, you can do it on your own. To establish your future valuation in the same year, multiply your EBITDA (Earnings Before Interest, Taxes, Depreciation, and AmortizationAmortization) from a certain year in your income statement by a multiplier (the recommended quantity to utilize for your multiplier varies by industry). The most common method to get your future valuation is EBITDA times the multiplier. However, different businesses use a variety of methods to evaluate their future valuation.
If you choose the option of taking a bank loan, then you do not require ROI. I say this because the bank makes money by the loans paid back and also with interest. Three factors decide how much money you have to pay back if you take a bank loan- the amount of loan, for how much period have you taken for and interest rate. They are bothered about your business plan. All they want is you to pay the debt on time and with interest.
If you’re looking for funding, potential investors will want to know all of the circumstances in which they can get out of owning a financial stake in the company. One option is for investors to sell their shares back to the company at a later date when their value has increased. The company is either failing and the investor is losing money, or the firm is flourishing and its shares are publicly traded on a stock exchange. Each anticipated exit option will be listed in an investor plan.
When it comes to a bank loan, you do not need an exit strategy. You do not require it unless you want to shut down the business till it reaches the term-end. The only thing the bank is concerned about is you pay the debt within the duration of time, also with interest. It does not care if your start-up is booming or not doing well.
If you take out a bank loan or another type of debt, interest should be reported on your income statement, while principal repayment should be reported on your cash flow statement. The interest expense and principal loan payback will both be nil if you are looking for an investment or other equity financing.
So, what kind of funding should I look for?
There isn’t a one-size-fits-all solution to this. On the other hand, banks are more willing to lend to tried-and-true business concepts. Investors, on the other hand, are usually more interested in innovative ideas. These ideas have the potential to disrupt the corporate environment in some way (e.g., food delivery apps). Another issue to consider is your credit history, as having a poor credit history may make it more difficult to secure a loan.