How Startup Type Affects Your Financing Options

By Fernando Berrocal

A business entity is comprised of a group of individuals (in some cases, a single person) who get together to carry out business, participate in commerce, or engage in similar activities. There are many different forms of business entities across the board. The type of business entity determines both the organizational structure and how the business deals with taxes

Business Entity

Determining the business entity type for your fledgling enterprise is a crucial task. New business owners can find this intimidating, but it's important to form a business organization as soon as possible.  The structure you pick will affect your organization's finances and legal standing. The financing choices you have are one of the most significant things that your business entity type can determine.

In the course of a business cycle, organizations will eventually look for outside funding. When this scenario arises, they frequently seek out commercial lenders for the extra financial infusion. However, lenders must assess the level of risk they would be exposed to before approving business loan applications. The business entity or structure of the organization is an element they examine. A business's incorporation process is referred to as its entity. The entity that owners select will determine how their organization is taxed and how that impacts their obligation or risk (in the case of a loan default or legal proceedings).

Currently, the U.S. recognizes four different business entity types: corporations (S and C Corp), Limited Liability Companies (LLCs), general partnerships, and sole proprietorships. Lenders will evaluate each business entity's level of liability (or risk exposure) as part of the application procedure. You could end up personally responsible for your organization's debts in the event of a loan failure, depending on the structure selected.

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General Partnerships and Sole Proprietorship

You may wish to take into account sole proprietorships or general partnerships throughout the early phases of your firm. In both cases, there is no distinction between personal and business assets. If the organization is unable to pay the loan, the lenders may proceed to the owners' private assets. In a sole proprietorship, the business is owned and run by one person. This indicates that the whole business obligation rests with that single person. Freelancing, service providers, or independent landscapers are frequently the kinds of firms that adopt this form.

Applying for loans from lenders, especially traditional ones, can be challenging for a sole proprietorship. The owner will be solely responsible for any obligations as the person and the business are virtually one entity. Additionally, since you won't be able to sell your stocks, bonds, or shares, banks could be reluctant to extend you a loan. The probability that banks will be paid back reduces as more parties seek to seize your business and personal assets. “Banks are reluctant to lend to a single proprietorship due to a perceived lack of trust when it comes to repayment if the firm collapses”, according to the Small Business Administration (SBA). Due to this, the lender bears the majority of the risk.

Financing Options Affected by Business Entity Types

General partnership businesses have several owners.  Each one is equally liable for the organization's debts and obligations. Regardless of what portion of the business each one owns, if one of the firm's owners takes out a loan and defaults, all the partners would be personally accountable for it. They are viewed as a higher entity since there are more persons involved, even though there is still a bigger risk. The bank can go after each partner's assets for loan repayment when a corporation has more than one partner. This raises the possibility that the business will be approved for cheap financing.

Limited Liability Companies (LLCs) and Corporations

The best personal asset protection is provided by these choices. Contrary to the previous examples, businesses organized as corporations or LLCs are thought of as independent from their owners. Your assets from both your professional and personal life will be treated separately. With this, the possibility of losing your private property due to loan default is avoided. The ease with which a business may sell its bonds, shares, and equity on the stock market makes it easier for them to get commercial loans. Since they are certain that their assets will be protected, investors are more willing to invest and purchase stocks.

With the adaptability of a partnership and the corporate asset protection of a corporation, an LLC is a hybrid entity. It is the sort of entity that is most suggested for expanding firms. If you want to increase your likelihood of receiving funding from investors, LLCs are often the ideal structure. Since they often have a proven track record of profitability and stability, these structures are seen as the most reputable by lenders since they increase the possibility that they will be paid. They also own more liquid assets (bonds, stocks, shares, etc.). Lenders are thus more willing to accept loan applications from businesses and LLCs and could even provide substantial funding amounts in addition to flexible financing terms.

Alternative Sources of Finance for Sole Proprietors

Their funding choices may be limited by the sole proprietorship's lack of credibility and inherent risk. They still have alternatives even if they will have a harder time being approved for accessible financing options. The SBA Microloan is an example of a common one. Private lenders make these loans, but they are supported by the SBA. Additionally, they are more difficult to get approved for than traditional ones, and the application procedure can be time-consuming (weeks to months). However, once accepted, you'll be able to benefit from inexpensive rates and flexible financing options.

Credit cards and business lines of credit are further alternatives. These are made specially to meet urgent demands. You will have access to a credit line with a predetermined limit if you have a credit card or line of credit. You simply need to take out what you need and add interest. The best aspect is that the money may be spent on a range of things, allowing firms greater choice with their expenditures. Numerous alternative peer-to-peer lenders focus on lending to high-risk borrowers such as sole proprietorships. Be aware that obtaining finance as a single proprietorship can be time-consuming and challenging, and that the rates are frequently higher.

Also, consideration for sole proprietorships is business grants (monetary awards given by the federal government or private organizations to businesses with high potential). Business grants do not have to be repaid, unlike loans. To convince the organization that your business merits a grant, submit an application and a strong business proposal.

What Entity Type is Right for my Business?

As a sole proprietorship or general partnership company, your funding options are limited.  Your opportunities to qualify for inexpensive loans also decrease. There are additional funding choices, however, such as those provided by alternative peer-to-peer lenders. Note: higher interest rates are typically associated with these choices. In contrast, corporations and LLCs have access to a wide range of business funding choices. As the most reliable type of business, they have a greater chance of securing funding with bigger loan amounts and more flexible conditions. Switching to a more established business structure might help you access additional funding choices if you're operating as a sole proprietorship or partnership.

In conclusion, the sort of corporation that is ideal for your business is a decision only you can make. It is advisable to conduct an in-depth study and think about speaking with an accountant or lawyer to assist you to sort through the jargon as you arrange the structure of your firm. The more information, the more prepared you'll be to make a choice.

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