A business finances its operations and expansion through some combination of five sources: cash it already earns, credit from suppliers, money it borrows, money it raises by selling ownership, and loans backed by the Small Business Administration. Which mix fits depends on the company’s size, its credit, how fast it needs to grow, how much control the owners want to keep, and how much personal risk they’re willing to sign for.
Using Cash the Business Already Has
The cheapest capital on paper is money the company already makes. Founders often start by putting in personal savings and living off early revenue. As the business matures, the equivalent is retained earnings: net income left over after operating expenses, taxes, and any distributions to owners. That pool sits on the balance sheet and can be reinvested without paying interest or handing out shares.
The catch is opportunity cost. If reinvested profits generate a 5% return while a loan at 8% would fund a project returning 20%, avoiding debt leaves money on the table. The real question isn’t whether internal funding costs less than borrowing. It’s whether the return on the reinvested dollar beats what outside capital could unlock. Conservative managers sometimes lean too hard on retained earnings and grow more slowly than competitors who use leverage on purpose.
Trade Credit From Suppliers
One of the most common forms of business financing doesn’t come from a bank at all. Trade credit means a supplier lets the buyer take delivery now and pay later, usually on terms like Net 30 or Net 60. During that window the buyer has short-term, zero-interest financing. It’s often enough time to sell inventory or deliver services and collect payment before the supplier’s invoice comes due.
Trade credit doesn’t require a loan application or a bank credit check. It’s negotiated directly with the seller, informally at first and more formally as the relationship grows. Many suppliers also offer early-payment discounts written as something like 2/10 Net 30, meaning a 2% discount for paying within 10 days instead of 30. Skipping that discount to hold cash for the extra 20 days carries an implied annual cost of roughly 36%, so passing it up is expensive unless the business is doing something productive with those days. For companies with quick inventory turnover and reliable customers, trade credit is the first line of defense for day-to-day liquidity.
Borrowing Money
When internal cash and supplier terms run out, businesses borrow. Debt creates a contractual obligation to repay principal plus interest on a schedule, but it doesn’t give the lender any ownership. Fixed cost in exchange for keeping control is why borrowing remains the backbone of business expansion.
Term Loans and Lines of Credit
A term loan is a lump sum for a defined purpose, like equipment or a buildout, repaid in fixed installments over a set period. Rates vary with the borrower’s credit, the loan size, and whether the rate is fixed or floating. Small business term loans commonly carry annual percentage rates well into double digits in the current environment, so shopping multiple lenders matters. Most commercial loans also carry origination fees and closing costs on top of the interest.
A revolving line of credit works differently. The lender sets a maximum limit, and the business draws against it as needed, paying interest only on what it uses. That flexibility makes a line of credit better suited to managing uneven cash flow, such as covering a slow month or bridging the gap between paying suppliers and collecting from customers, rather than funding one big purchase. The business can draw, repay, and draw again through the term.
Secured Lending, Covenants, and Prepayment
When a lender wants collateral, the transaction falls under Article 9 of the Uniform Commercial Code, which governs how a security interest is created and enforced. The lender files a UCC-1 financing statement with the appropriate state office to give public notice of its claim on specific collateral, whether that’s equipment, inventory, receivables, or intellectual property. If the borrower defaults, the lender can repossess and sell the collateral.1Cornell Law School. UCC – Article 9 – Secured Transactions
Most commercial loans also include restrictive covenants. A lender might require a minimum debt service coverage ratio of 1.25, meaning the business earns at least $1.25 for every $1.00 of scheduled debt payments. Other covenants cap total leverage or require a minimum level of working capital. Breaking a covenant can trigger a default that lets the lender demand immediate repayment of the full balance, even if every scheduled payment has been made on time.
Prepayment penalties are the other cost borrowers sometimes miss. Paying off a loan early costs the lender its expected interest, and many commercial loan agreements charge a fee to make that up. The two common structures are yield maintenance, which ties the fee to Treasury yields, and step-down penalties that decline over the life of the loan. Negotiating these terms at signing matters, because exiting early can be expensive.
Asset-Based Lending and Invoice Factoring
Companies with valuable assets but thin cash can turn those assets into liquidity. Asset-based lending uses receivables, inventory, or equipment as collateral for a loan or line of credit. Invoice factoring is different: instead of borrowing against receivables, the business sells its unpaid invoices to a factor at a discount. The factor advances 80% to 90% of face value up front, collects directly from the customer, and remits the rest minus its fee.
The key distinction is recourse versus non-recourse. Under a recourse agreement, the business has to buy back any invoice the customer never pays. Under non-recourse, the factor eats that loss, though many non-recourse contracts still carve out exceptions like customer bankruptcy. Non-recourse costs more because the factor is taking on more risk. Factoring works best for businesses with creditworthy customers and predictable billing cycles, where the discount hurts less than waiting 60 or 90 days.
Commercial Paper (Large Companies Only)
Large corporations with strong credit can skip banks and issue commercial paper, an unsecured promissory note sold directly to investors. Maturities go up to 270 days but average about 30, and the 270-day ceiling is there because longer maturities would trigger SEC registration.2Board of Governors of the Federal Reserve System. Commercial Paper Rates and Outstanding Summary It’s usually cheaper than a bank loan, but it’s only open to investment-grade issuers. Small and mid-sized businesses won’t have access.
Selling Equity
Selling ownership shares brings in capital without a repayment obligation. The tradeoff is permanent. The founder gives up a piece of future earnings and a piece of decision-making, and both compound as more rounds close.
Angels and Venture Capital
Early-stage capital typically comes from angel investors writing smaller checks or venture capital firms writing larger ones, usually in exchange for preferred stock. Preferred shares carry rights common stock doesn’t, including liquidation preferences that pay the investor back before founders see anything in a sale. Each new round issues more shares and dilutes the founders’ percentage. A founder who starts with majority control can hold less than 20% by the time a Series D closes, with voting power falling along with the equity stake.
Regulation D Private Placements
Private companies selling securities have to comply with the Securities Act of 1933, but most avoid full SEC registration by using an exemption under Regulation D. Rule 506 lets a company raise unlimited capital from accredited investors without filing a full registration statement.3eCFR. 17 CFR Part 230 – Regulation D – Rules Governing the Limited Offer and Sale of Securities Without Registration Under the Securities Act of 1933 An accredited investor generally has a net worth over $1 million excluding a primary residence, or annual income above $200,000 individually or $300,000 jointly for the prior two years.4SEC. Accredited Investors Companies still file a Form D notice with the SEC, prepare a private placement memorandum, and remain subject to anti-fraud rules, so the paperwork is lighter than a public offering but far from zero.
Regulation Crowdfunding
Smaller companies that can’t attract accredited investors have another route. Regulation Crowdfunding lets a business raise up to $5 million in a 12-month period from everyday investors through SEC-registered online platforms. Non-accredited investors face annual caps across all crowdfunding offerings, and securities purchased through crowdfunding generally can’t be resold for one year.5SEC. Regulation Crowdfunding It tends to work best for consumer-facing businesses that can turn existing customers into investors.
SBA-Backed Loans
The Small Business Administration doesn’t lend directly. It guarantees a portion of loans made by banks and credit unions, which lowers lender risk and helps businesses that otherwise wouldn’t qualify get approved. Two programs do most of the work. The statutory authority sits at 15 U.S.C. ยง 636, which lets the SBA make or guarantee loans for plant, construction, expansion, equipment, and working capital.6Office of the Law Revision Counsel. 15 USC 636 – Additional Powers
The 7(a) Program
The 7(a) program is the flagship and covers the widest range of uses, from working capital and inventory to equipment and real estate. Maximum loan size is $5 million.7U.S. Small Business Administration. 7(a) Loans The SBA guarantees up to 85% of loans of $150,000 or less and 75% for larger amounts, which is what gives lenders confidence to approve borrowers who would otherwise be too risky.8U.S. Small Business Administration. Types of 7(a) Loans Rates are capped at a spread above prime that varies by loan size, with smaller loans allowed a wider spread. Borrowers still have to meet SBA size standards, either the industry-specific thresholds or, alternatively, a tangible net worth of no more than $20 million and average net income of no more than $6.5 million over the prior two fiscal years.9eCFR. Part 121 Small Business Size Regulations
The 504 Program
The 504 program is narrower. It funds long-term fixed assets: commercial real estate, land, and heavy equipment with a useful life of at least 10 years. Maximum loan size is $5.5 million.10U.S. Small Business Administration. 504 Loans Because 504 loans are long-term and fixed-rate, they’re a good fit for buying a building or expensive machinery without the exposure that comes with a variable rate.
How Taxes Change the Math
The choice between debt and equity looks different once taxes come in.
Interest on business debt is generally deductible. A company in the 21% federal corporate bracket that pays $100,000 in annual interest cuts its tax bill by $21,000, so the after-tax cost of that interest is $79,000.11Office of the Law Revision Counsel. 26 US Code 11 – Tax Imposed That built-in subsidy is one of the main reasons companies with steady cash flow lean toward debt.
The deduction has a ceiling. Section 163(j) of the Internal Revenue Code limits the business interest deduction to business interest income plus 30% of adjusted taxable income.12eCFR. 26 CFR 1.163(j)-2 – Deduction for Business Interest Expense Limited Small businesses with average annual gross receipts under roughly $32 million are exempt.13IRS. Questions and Answers About the Limitation on the Deduction for Business Interest Expense
Equity has no equivalent deduction. When a C corporation earns a profit it pays the 21% corporate tax, and when it distributes the profit as a dividend the shareholder pays tax on the same income again.11Office of the Law Revision Counsel. 26 US Code 11 – Tax Imposed That double taxation is a major reason smaller businesses often organize as pass-through entities like S corporations or LLCs instead.
One offset for equity investors is Section 1202 of the Internal Revenue Code. A shareholder can exclude up to 100% of the gain from selling qualified small business stock held for at least five years, if the stock was issued by a C corporation with aggregate gross assets of $75 million or less at issuance and the corporation meets active business requirements throughout the holding period.14Office of the Law Revision Counsel. 26 US Code 1202 – Partial Exclusion for Gain From Certain Small Business Stock For founders and early investors in qualifying startups, 1202 can wipe out federal capital gains tax on a successful exit.
Personal Guarantees and Owner Liability
Most lenders won’t extend credit to a small business without a personal guarantee from the owner, especially when the company is young or lightly capitalized. A personal guarantee puts the owner’s personal assets on the line: home, savings, vehicles. The corporate liability shield that comes with an LLC or corporation doesn’t protect against an obligation the owner has personally guaranteed.
If the business defaults, the lender can sue the owner directly, get a judgment, and pursue wage garnishment or liens on personal property. Some guarantees include a security interest in specific personal assets, which lets the lender repossess collateral without first winning a judgment. Read guarantee terms carefully. Signing one converts a business debt into a personal one, and negotiating a limited guarantee that caps personal liability at a specific dollar amount is sometimes possible and always worth asking about.