Which Type of Capital is Right for Your Business?Small Business Tips and Tools•Apr 27, 2023• 3 min read
One of the biggest challenges entrepreneurs face is how to best fund their small businesses. Choosing the right capital for your situation can have important consequences for how a business grows and operates for years to come.
There are essentially two types of capital – debt and equity. Each type contains a range of more specific, nuanced options to help grow your business. Oftentimes, a business will require a mix of both types. In this blog post, we’ll break down some of the considerations every small business owner should make as they navigate different forms of capital.
Rule #1: Start with What You Have
Most experts recommend that small business owners dig into their own pockets before seeking any sort of outside funding. Using your checking account, selling stock or bonds, or putting up collateral assets such as your home allows you an interest- and equity-free source of capital. You may have heard this approach referred to as bootstrapping.
Bootstrapping a business is a great way to validate your idea and business model without investing significant resources. This approach helps you test your minimum viable product, gather initial customer feedback, and ration your valuable resources for a time in the future. It also proves to potential investors that you have “skin in the game” and are serious about the business idea.
That said, there will inevitably come a time when your business will require outside funds to fuel growth. That’s when it’s time to think about debt and equity!
Debt Capital 101
You take on debt every time you enter into a loan agreement. The wonderful thing about debt capital is that you don’t surrender an ownership stake in your company. However, you might have to provide collateral, and you’ll have to pay back the balance. Interest payments can significantly add to the cost of this type of capital.
Many business owners take out small business loans to fund their business. Securing a loan from a bank, credit union, or through the Small Business Administration (SBA) can finance new equipment, fund operations, or help you expand to a new location. Keep in mind that your access to this type of capital can be limited by your personal credit score, the health of your business, access to collateral, and other factors.
Traditional lenders can also be conservative with their decisions. If you need a significant infusion of capital to fund your business, it might be time to look to equity capital.
Types of Equity Capital
Pursuing equity capital has unique pros and cons. On the one hand, it’s one of the fastest ways to receive a large infusion of capital from an investor or group of investors. These investors could become valuable business partners and mentors. On the other hand, pursuing equity means surrendering ownership and decision-making power.
One source of equity capital is the friends and family round. In this arrangement, you provide a stake in your business to someone in return for an investment. This is typically done in the early stages of a business.
You can also take the Shark Tank route. Angel investors and venture capitalists who are willing to take a chance on your business can be an invaluable source of knowledge and mentorship. If you are able to sell your business with a great pitch, these investors could reward you with a significant amount of capital in exchange for a piece of the company.
Crowdfunding is also an increasingly popular source of capital. Through a platform such as WeFunder, you can solicit many smaller investments in exchange for equity, rewards, or even debt. Hello Alice has a step-by-step guide to help you understand the different types of crowdfunding and how to get started on popular platforms.
In select cases, you could even pursue an initial public offering (IPO) that lists your business on a stock exchange so the public can purchase shares (and therefore equity). This type of capital is reserved for more mature small businesses.
Other Ways to Fund Growth
An oft-overlooked source of funding is small business grant programs. These debt-free cash injections don’t surrender equity and don’t need to be paid back. You can find tons of local, state, federal, and private business grants ready to fund your business. Writing a winning grant application takes time and effort, but you could be rewarded with what’s essentially free money.
Similarly, pitch competitions are an opportunity to win a one-time cash prize. They also serve as invaluable networking opportunities that will expose you to potential mentors, investors, and media opportunities that could pay off for years to come. Consider mastering your elevator pitch and looking for upcoming competitions at conferences, universities, or your local business support organizations.
Finally, businesses at all stages should pursue strategic partnerships. By working with another organization that shares a common mission or vision, you have the potential to hack your company’s growth in ways you never imagined possible. Making the most of strategic partnerships provides a low- or no-cost way of expanding your company’s reach, providing new opportunities, and enhancing your brand’s reputation.