How to Choose the Right Type of Project Finance for Your Business
Any business needs capital funding from outside sources. Even in the case of large companies, there are instances that they seek capital infusion for growth and expansion.
Here are the sources which provide finance for your business in case of need:
- Debt Financing: When your business needs funds, any loan taken from a bank/financial institution to tide over the situation is debt financing. In simple terms, it may be an overdraft, cash credit limit, Machinery loan etc.
The advantage of debt financing is that the lender has no control over the business. So, freedom of taking business decisions is not affected in any way. The interest payment can be claimed as an expense.
The disadvantage is that the repayment starts in the near future and any delay in repayment will affect the credit rating of the borrower.
- Equity financing:
Equity finance is the funding obtained from investors who are mostly wealthy individuals. They infuse the capital required which can be used for meeting the needs of the business.
The advantage of equity funding is it need not be repaid since the person who contributes the fund will become an investor in the business. This will greatly help in maintaining liquidity since loan repayment is not there.
- Mezzanine capital funding:
In equity financing, the borrower has to consult the investor for all business decisions which affects the decision making the power of the borrower. Mezzanine capital is a combination product of debt and equity financing which avoids above disadvantage. Initially, the mezzanine capital is given as a loan which can be converted to equity at a later stage of business. The rate of interest is usually high for mezzanine capital funding.
- Funding from family and friends:
If the amount needed is small then it can be sourced from family and friends. The advantage is that the repayment term is very flexible. Also, this does not involve delay since there is no complicated documentation/legal formalities. Such transactions when promptly repaid increases mutual regard and trust. But there is always the risk of damaging the relationship if the business meets loss and is unable to repay the loan.
Depending upon the amount needed, liquidity and urgency any of the above modes of finance can be chosen.
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