10.2.17 – Funding vs. Lending: Understanding the Difference
There is a wide array of different reasons why a small business might need access to extra incoming cash at any particular moment. Sometimes, they need to deal with a sudden-yet-important extended supplier payment. Other times, they’re just looking for new ways to better deal with seasonal cash fluctuations. Often, they’re dealing with customers who just can’t seem to pay on time. According to one study, invoices to small businesses were paid an average of 22.5 days late in 2015.
Regardless of the reason, it’s always important to know your options before you begin looking for new opportunities to ease these potentially troubling times. In terms of funding vs lending, for example, you’ll always want to keep a few key things in mind.
Lending: An Overview
Lending, by its very definition, is the process of granting the use of something with the express understanding that it will eventually be returned. In terms of a small business, this means that you’ve found someone who can give you the funds you need under the assumption that you will eventually be paying it back. It’s important to note that a loan requiring regular repayments can actually cause greater cash flow constraints on your business and sits as a liability on your balance sheet — affecting your capacity to borrow in the future.
This is a common practice for businesses in need of a bit of extra cash and opens the door to a variety of options depending on your situation. You could choose to take out a small business loan for general funds, for example, or something like a payroll loan or other specific type that better addresses your current needs.
Depending on the situation, lending may be the more difficult option of the two due to ever-tightening federal regulations along with the strict criteria banks hold small businesses to.
Funding: What You Need to Know
Funding, on the other hand, is money that you are provided with for a particular purpose. Take invoice financing, for example. In this situation, you would essentially find a company to “buy” your current invoices for a specific percentage. You get money immediately, and the process of actually collecting on those invoices becomes the responsibility of the lender. You might get up to 80% of the money now, and the invoice financing company sends the rest when they collect, for a fee.
The key difference here is that in funding, the money you get does not need to be repaid.
Lending vs Funding: The Considerations
Both lending and funding have their fair share of advantages and disadvantages, depending on what you’re trying to accomplish. Lending, for example, adds an immediate financial strain to your business — it makes debt worse, it often comes with high interest rates, and it can even occasionally raise privacy concerns. The flip side of this is that you get immediate access to the funds you need when you need them the most.
Funding, on the other hand, gives you a much higher chance of securing the money you need — particularly if you don’t fit into the bank’s loan criteria. The size of your business doesn’t necessarily matter as much as it does in a lending situation as funders are often in a much better position to help startups. Funding is also less intrusive on the business in general, as you’re not worried about an additional line item on a balance sheet.
Overall, the main difference is, lending is using someone else’s money whereas funding is using your own money. This means, funding is not a liability on your balance sheet.
The Choice Is Up to You
Again: both lending and funding have their strengths and weaknesses, depending on exactly what you need and when you need to do it by. There is truly no “one size fits all” answer to this process, and it is up to you to put the required research in ahead of time to avoid falling into a predatory trap. Lending gives you access to a huge array of different types of loans, but you’ll always be working with the express understanding that this money will eventually be paid back — often at a high interest rate. Funding, on the other hand, gives you a higher chance of actually getting the money you need in a way that does not need to be repaid.
At the end of the day, the choice is yours and yours alone to make. Only after weighing the pros and cons of each option will you be able to identify the one that is the best match for the situation you find yourself in.