With last year’s historic boom in startups still surging ahead in 2021, many entrepreneurs are looking for ways to attract capital. In order to tap into appropriate financing sources, however, it is wise for the Illinois business owner to be aware that the choice of entity can greatly influence the kind of financing it will attract.
What are the main sources for funding a business?
Every business requires funding in order to stay afloat. The main sources generally come from personal, corporate or governmental financing, or any combination of these. New business owners often need more than funding from personal savings, and so will seek outside sources as well. The main external financing options are:
- Equity financing, in which funding is given in exchange for partial ownership or future profits
- Debt financing, which is a loan that must be repaid with interest.
- Government funding, which can be obtained through grants or scholarships and do not need to be repaid, coming from government agencies, nonprofit organizations or for-profit companies.
As new businesses do not have a history, they carry greater risk for a lender. Established businesses will have a record of performance from financial statements that reveal their overall profitability. As a result, a new startup will more likely attract equity financing, as its potential will likely yield greater profit at the outset, while a mature business will more easily access debt financing.
How does entity selection influence funding availability?
It is estimated that 70% of businesses in the United States are sole proprietorships, and over 3.3 million are general partnerships. Although these two business types have the greatest personal liability, they also offer the greatest flexibility in how to run the business. However, as personal assets are more difficult to seize in the event of default, most banks will see these entities as too high-risk.
Limited liability corporations, C-corporations and S-corporations are set up to protect an owner’s personal liability. Corporations are owned by shareholders, while LLC’s have the flexibility of a general partnership, but with limited liability. As lenders prefer the business to shoulder liability without a blending of personal assets, these entities are more likely to attract financing.
In the big picture, it all comes down to liability. Because lenders prefer the option of seizing business assets in the event of default on the debt, they will be attracted to business entities that have minimal personal liability. But those with greater personal liability have greater flexibility in borrowing options.
It can be beneficial to have experienced legal advice serving Godfrey and surrounding areas to discover best options to get a new startup off the ground.
