Undertaking a start-up is no plain sailing. From an outstanding idea to initial capital, you have to work on many things before taking the plunge. When it comes to financing your business, you have two options – self-financing and external financing. Which one best suits your needs depends on multiple factors, and each of them has some pros and cons.
The first thing you need to understand is what exactly these two types of funding are. Self-financing is a method of funding your business using your own money that can be in the form of your savings, liquidating your investments and your home equity. It can be your business credit card if the sum is not too big to be invested in your business. Under this method, you are not borrowing a single penny from outside, like capitalists and lenders. You are absolutely free to use the money the way you want.
On the contrary, external funding involves borrowing money from banks, lenders, or credit unions and raising money from capitalists. Funding from external sources does not mean that you will not use your savings at all, but the start-up cost will include a portion of loans.
Self-funding pros and cons
Self-funding sounds intimidating especially when your business is too risky. You will end up losing the whole of your money if it does not take it off the ground. However, there are other types of risks when are using external funding sources. First, look at the pros and cons o self-financing:
Advantages of self-financing
- Full ownership
If you self-finance your business, you will be able to make all the decisions yourself. No interruptions or interventions will be faced. In simple words, you will be in charge of your business. All important decisions will be made by you – whether or not to invest in a project or how much funds to be invested in a particular project. Since you have complete ownership of your business, you will be responsible for enjoying all profits.
As you will have full control of your business, you can run it the way you want. There will not be any restrictions from banks, lenders or investors on how you have to use your money. You will have complete freedom to manage your business operations. You can make decisions about cash flow, production, sales and marketing.
- It ensures future funding is much easier
Though you have invested your own money in your business, it does not mean that you will never be able to borrow from external sources. When you want to borrow, you will have to prove that your business is picking up steam to get the nod from your lenders.
Self-financing will help you win the trust of your lenders and they will likely offer you a loan at a lower interest rate. Your prospects of securing finances from lenders or investors will be high in the future.
Drawbacks of self-financing
- Growth limit
If you are financing your star-up with your own resources, you will have to ensure that your business is supplied with cash until it starts generating profits. It may take a long time. Chances are your business grinds to halt.
- The Risk is too high
You are completely responsible for meeting financial commitments. If your business fails to generate enough profits, you will have to meet other expenses like bills, rent, and payroll from your pocket. You might have to cash out some of your assets. The risk is outrageously high.
Pros and cons of external financing
External funding allows you to borrow from external sources. If you borrow from a lender, you will pay interest. If you raise funds from investors, you will have to give them a share in your equity. External funding has some benefits, but they are also subject to certain drawbacks.
Advantages of external funding
- Your resources remain preserved
If you borrow money from a business lender broker, one of the greatest advantages is that your resources remain preserved. Though you have to pay interest on top of what you borrow, the payment is not to be made in a lump sum.
You will pay every month a fixed sum of money towards your debt, so it will be manageable along with your other business operations. Your savings can help you tide over when you come across some sort of emergency.
- Higher prospects of growth
You are likely to retain cash for a longer period of time if you borrow money from lenders. You can easily use this to invest in beneficial projects. As most of the money will be retained, you can easily invest your money in various high-profit, yielding projects.
Drawbacks of external funding
- You will lose ownership
Lenders cannot always be the best choice when it comes to investing in your start-up. In case you want to raise a very large sum, you will have to contact investors. They will get a share in your equity, which means you will not be completely responsible for making business decisions.
- Higher risk of losing assets
If you get a business loan secured by real estate, you will likely lose your assets if you fail to repay the debt on time. Interest and fees can be high when your credit score is not so stellar and if you are borrowing money for a start-up. They are usually considered riskier than established businesses.
If your business or your project fails to generate revenues, you cannot flinch from clearing the debt. You will have to dip into your cash reservoir. If you still struggle to keep up with payments, your lender will take back your property and liquidate it to cover your loan balance.
The bottom line
Self-funding and external financing can be used to finance your start-up, but remember that they have some drawbacks. You should choose an option that best suits your interests in the long run. For instance, if you are concerned about losing your equity, you should drop the idea of raising funds from investors. Instead, choose lenders. You should always use both types of funding because it will help you find equilibrium in funding options.
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