There are two broad types of financing for a business at any stage, but both are more challenging for start-up and early stage ventures. Why?
Debt financing typically is in the form of secured or unsecured loans, in which a lender provides cash to the borrower over a set period of time for an agreed-upon rate of interest and pay-back terms. Unsecured loans are extremely rare; far more common are secured or collateralized loans, for which the borrower provides collateral. Collateral represents something of worth, such as a personal residence or other property, and the lender can take possession of that property if the borrower defaults on the loan. Many entrepreneurs risk their own properties to acquire early-stage debt financing, and it is very risky as a result.
Equity financing is typically stock, and in this option, the financier is an investor, not a lender. The investor can be an individual, family or organization, and can invest owned funds, or represent others’ funds, which is what venture capitalists do. The business owner does not have to pay anything back, as no loan is involved, but gives up an agreed-upon percentage of ownership to the investor, who typically takes a minority position in the business (less than 50%). Many investors also require an element of management control as part of the deal. Rather than expecting interest payments, the investor expects the business to generate a specific ROI (return on investment) within an agreed-upon timeframe. If the ROI is not achieved, the investor may pull out of the agreement, leaving the business in a financial hole.