Ketan Kumar’s unique business plan helped him bag great success in a short time, that too without any financial assistance from a third party. However, to expand his business, Ketan is now seeking different sources of business finance. Like Ketan, if you too are an entrepreneur who needs funds for your business, then read on.
Today, in this article, we will discuss different sources of finance for small businesses in India.
Different Sources of Business Finance in India
Retained Earnings
Retained earnings are one of the most common sources of finance for business expansion. The primary goal of any business is to make a profit by selling goods or services. Under retained earnings, businesses can use earned profits in many ways. If the company is a large corporation, they can use the profits to pay dividends to shareholders, fund projects, and so on. Small businesses, on the other hand, can use the profits to expand their operations, pay their employees, buy machinery, and so on.
Benefits of using retained earnings
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Control
You keep complete control of your business and its operations by using retained earnings instead of seeking external financing or giving up equity to investors.
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Lower costs
Retained earnings are a low-cost source of funding, as they do not involve interest payments or fees associated a loan.
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Flexibility
Using retained earnings provides flexibility in how you allocate your funds, allowing you to invest in new opportunities or address unexpected expenses without the restrictions that come with external financing.
Drawbacks of using retained earnings
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Limited resources
If you are a small business, resources may be limited, and relying solely on retained earnings may limit your ability to pursue growth opportunities or respond to unexpected challenges.
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Risk of mismanagement
Using retained earnings without a clear plan can lead to mismanagement of funds, resulting in wasted resources or poor investments.
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Reduced liquidity
Retaining earnings can reduce your business liquidity, making it difficult to attract new investors or sell your business in the future.
Debt Capital
Debt capital or debt financing is another common source of business finance. Under this financing agreement, the borrower or debtor has to repay the money to the creditor or lender on an agreed-upon value that includes the interest component as well. If you are looking for the best financing options for a business, take a look at the debt financing possibilities listed below:
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Business Loans
It is rare to come across a successful business owner who has not taken any form of a business loan. As classified into secured and unsecured business loans, these loans come in a customised form. You can easily find products such as business expansion loans, working capital loans, commercial loans, and more.
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Loan Against Property (LAP)
If you are looking for a loan for your new business and have a real estate property in your name, a loan against property can help you in raising funds. As most lenders are hesitant to give business loans to start-ups, LAP is one of the best financing options for entrepreneurs who own a commercial or residential property. Moreover, mortgage loans against property come with longer repayment tenure and lower interest rates.
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Personal Loans
If you are denied a business loan despite seeking a small loan amount, you can always take a personal loan. Personal loans are granted based on the applicant's profile instead of business profile. Having solid credibility and steady income can help you and your company in raising money.
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Corporate Bonds
If you are a well-established business owner, you can raise funds from the public by issuing corporate bonds. Businesses utilise this type of financing to supplement or replace financial institutions loans as well as to fund projects and expand their operations. Under corporate bonds, the company receives the fund it requires and the corporate bond investor receives a predetermined amount of interest payments.
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Other Debt Financing Options
As a debt financing option, you may also opt for loan products such as bank overdraft, line of credit, term loans, promissory notes, debentures, and lease financing, among others. To identify a source of business financing that best suits your need, weigh the benefits and drawbacks of various debt financing options before making a decision.
Benefits of debt financing
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Lower cost of capital
Debt financing tends to be less expensive than equity financing. Lenders usually charge interest on the money they lend, which can be lower than the returns that equity investors expect.
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Flexible terms
Debt financing can be structured in many different ways, depending on the needs of the business and the lender. For example, businesses can choose between fixed or variable interest rates, and they can negotiate the repayment schedule and other terms of the loan.
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Tax advantages
Interest paid on business loans is typically tax-deductible, which can help to lower a company's tax bill.
Disadvantages of debt financing
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Repayment obligation
Debt comes with a repayment obligation, which means that you will need to make regular payments, including interest, over a set period. This can be strenuous on your company's cash flow and limit your flexibility to pursue other opportunities.
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Risk of default
If your company is unable to meet its debt obligations, it could lead to default, having severe consequences for your company's credit rating, as well as your ability to secure future financing.
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Interest costs
The cost of interest can be a significant expense for small companies if interest rates rise or you have a high level of debt. This can cut your profits and limit your ability to invest in growth opportunities.
Also Read: Small Business Loan - How to Get One Equity Capital
Are wondering how to get funding for a business idea? Well, equity capital is the answer. Under equity capital, you can raise funds from the general public. In exchange, the investors get a share of your company. Investors who purchase a share of your company become shareholders as a result of this financing. To grasp a better understanding of equity capital, let's understand some of the common equity capital sources of finance for business expansion.
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Angel Investors
Under this, you can raise funds from high net worth individuals who love investing in nascent stage firms. Angel investors contribute funds in exchange for shares of ownership or convertible debt. When other investors are not interested in your start-up, this is one of the best sources of finance for business.
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Venture Capital
If you are a start-up and are concerned about loan repayment, seeking funding through a venture capital firm could be an excellent decision. These venture capital firms can assist you not only with finance but also with business training and making connections in the industry. These venture capital firms make long-term investments in businesses that have the potential to grow, in exchange for a share of ownership or equity.
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Crowdfunding
Under this equity capital financing method, in exchange for the firm's securities, you can raise funds from a large number of potential investors through online platforms. By using this type of alternative financing, you can fund your project or an expansion plan.
Benefits of equity financing
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No repayment obligation
Unlike debt financing sources, equity financing does not require repayment, providing small businesses more flexibility in managing their cash flow.
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Access to expertise and resources
Equity investors often bring more than just money to the table. They may also offer industry knowledge, business expertise, and connections to other resources that can help your company grow.
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Long-term funding
Equity financing can provide your company with long-term funding, which can be particularly valuable for companies that need significant capital investments to grow.
Drawbacks of equity financing
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Loss of control
When you bring in equity investors, you give up a portion of ownership in your company. This can mean that you lose some control over crucial business decisions.
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Dilution of ownership
Bringing in new equity investors can also dilute the ownership of existing shareholders, which can lead to disagreements over the company's direction.
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Higher cost of capital:
Equity financing is typically more expensive than debt financing, as investors require a higher return on their investment to compensate for the risk they are taking on.
Also Read: Fuel Your Business Growth with Unsecured Business Loans Government Grants
This source of finance for small businesses is mostly available to businesses that directly or indirectly work for environmental or social causes. For example, if your business contributes to the conservation of non-renewable resources through the use of renewable resources, you might get financial assistance from the government for your business.
To Conclude
Every business owner seeks a loan for business expansion at some point. Whether you are a start-up or a well-established company, growing your business without financial aid is hard. Therefore, you can use the above-mentioned financing sources to expand your business or you can try availing government loans such as the Mudra loan, MSME government business loan, and Credit Link Capital Subsidy Scheme, among others. However, remember to evaluate your needs and weigh the pros and cons of different sources of business finance before making a decision.
Disclaimer: This post was first published on 29th September 2021 and has been updated for the latest information, freshness and accuracy.
