The Office of Advocacy recently published a study that revealed that the majority of small privately owned businesses opt for debt financing over equity financing. The report studied two competing capital structure theories - the “pecking order” theory and the “trade-off” theory.

According to the “pecking order” theory, small companies finance their assets in the following order: internal capital, debt, equity. The “trade-off” theory, however, says that small businesses prefer the tax benefits of deductible interest and therefore, debt financing.

After extensive statistical analysis, the Office found that the “pecking order” theory most adequately describes the capital structure of small privately owned firms. The study also found that generally a firm’s age, size, profitability, liquidity, risk and use of financial services correlates with the business’s leverage ratio (debt divided by equity). Typically, firms that are younger, less profitable, smaller, riskier, less liquid, and/or obtain more financial services from bank or non-bank institutions have higher leverage ratios.

For more information on the study’s findings, refer to theSBA report.

The Small Business Administration recently launched an online tax savings resource center to assist small companies in identifying the benefits of the economic stimulus package introduced in January of this year. The resource center explains the new tax benefits and estimates the first-year depreciation for small businesses using online calculators and tutorials. Because the SBA found that most small businesses remain unaware of the benefits of the package, officials hope that entrepreneurs will take the advantage of this resource.

The stimulus package increases the expensing limit from $128,000 to $250,000 and amount of depreciation deduction by 50 percent in the 2008 tax year. However, it is worthwhile that small businesses consult their tax advisor as there might be exceptions and provisions to these benefits.

For SBA resource center, visit www.sba.gov/stimulus/ and for details of tax changes visit the Internal Revenue Service’s Web site.

Biz2Credit recently attended the TIE conference in Santa Clara, CA. At the entrepreneurial network and showcasing conference, we spoke with a lot of small business owners, most of which were in the tech sector and most of which were chasing Venture Capital funds to raise money for their businesses.

Though equity financing may seem like the ideal way to finance business expansion plans, all small businesses should seriously consider the road more traveled by. Debt financing can be a vying contender, if not a superior alternative to equity financing. Today’s Venture Capital market looks barren next to the funding spree of the late 1990s and early 2000s that gave VC financing its sexy reputation.

That’s not to say taking out a loan doesn’t have substantial drawbacks for a small business. Debt financing during the credit crunch can be challenging, unpredictable and expensive.

So which one is better – debt or equity financing? It’s a decision that most businesses face early in the life cycle of the company, and it’s not easy. We’ve outlined three essential situations where debt financing can provide quick working capital relief.

Years in Operation

Small businesses more than 18 months old should aggressively apply for an SBA-backed line of credit product. Even amid the credit crunch, banks will accept stated income from small business owners and lend to established companies.

Cash Flow

Small businesses with a strong cash flow can easily qualify for accounts receivables financing. Most entrepreneurs assume that factoring is the only debt option available, however, banks will accept accounts receivables for collateral on a line of credit product – a much cheaper and better alternative.

Owner Equity

Some banks even have a credit program that lends against the owner’s equity contribution. Small business owners that have invested a substantial amount of their own funds or have used angel financing should strongly consider this option.

Read on for more information on how to get the appropriate financing for your small business:

• SBA Loans
• Small Business Financing Alternatives

Most small business borrowers often struggle to identify the best time to refinance. We outlined five common situations where you should refinance and consolidate your small business loans.

Old SBA Loans
Most entrepreneurs use SBA loans to buy a business. Usually, rates of SBA 7a loans are tied to Prime for a 3-year lock in period where pre-payment penalties apply. Loans that do not include real estate normally span 10 years and those with real estate span 20 to 25 years. Those businesses that were purchased in the last 3 years should refinance and lock in a lower interest rate.

Expanding Businesses
SBA loans put an all encompassing lien on a business and impede company growth and financing options. In this situation, business owners should pay the prepayment penalty, take the tax write-off and refinance their debt to improve credit access and company growth opportunities. Growing businesses that were originally purchased with an SBA loan should refinance with a conventional loan.

Land contracts
In this low interest rate environment, businesses that refinance land contract deals with SBA acquisition loans will save around 3 to 4 percent and extend the term of the loan.

Lines of Credit
Businesses operating for over 18 to 24 months can take advantage of the low interest products like unsecured lines of credit. Businesses maintaining good business and personal credit levels will see the most cost advantage.

Leveraging Accounts Receivables
Growing businesses can leverage high accounts receivables to obtain cheaper financing. Normally, banks lend up to 80 percent of a business’s accounts receivables at rates of around Prime plus 2. This can be used to prepay high cost loans received when the business lacked goodwill and strong receivables to qualify for less expensive financing options.

Read more to find out how to refinance and lower business loan payments.

In a sluggish economy, business owners must maintain a good credit score (above 680) in order to keep their financing options open.

Paying bills on time (especially mortgages) is only part of the solution. Small business owners should keep debt-to-income (DTI) ratios below 50 percent. Because credit bureaus do not track personal income, they monitor the DTI by looking at outstanding credit card bills and other revolving and installment payments such as mortgages and student loans. When credit card payables exceed 50 percent of the total credit card limit, the FICO model puts an individual in a riskier category compared to someone with a DTI less than 50 example.

For example, a person with two credit cards, both with a limit of $20,000 and a balance of $5,000, will have a higher credit score than someone with one card with a limit of $20,000 and a balance of $10,000. Therefore, small business owners who need to borrow more than 50 percent of their credit card limit should apply for another card.

It’s important to note that, business credit cards do not affect the DTI. For more information on building credit check out our recent blog posts:

• Catch Mistakes on Your Credit Report
• How Is My FICO Score Determined?
• What Happens to Your Credit Score when Someone Views Your Report

Over the last 10 years, India’s emergence as one of the world’s premier outsourcing hubs has mostly helped multinational corporations and Fortune 500 firms increase their bottom line. But small businesses that effectively identify and manage offshore projects can also tap into these cost savings, increase margins and level the competitive playing field. With limited resources and room for trial-and-error, small business owners must conduct rigorous background checks on potential service providers in India.

The trick is how…

For all IT and BPO related services, small business owners should check the National Association of Software companies (Nasscom) for a database of registered companies.

Small businesses and freelancers can be found on Web sites that rank service providers or BPO companies. Also, alibaba.com is a great resource for manufactured good providers.

For a more indepth look at outsourcing to India and China check out our recent blog post!

Businesses mark up prices as a result of heightened demand. However, with the rising oil and food prices driving inflation, small business owners must increase the price of their goods and services to cover higher costs.

Even with the unemployment rate up and wage costs sinking, businesses still see costs rising. Prices have increased 5 to 10 percent for restaurants, retail establishments and other businesses tied to the food and oil industry.

To lower costs, small businesses in the service industry should outsource backend labor to states with rampant unemployment and low wages like Florida and Michigan. Also, small businesses that export goods and services can effectively take advantage of the increased competitiveness that the falling dollar has given American companies.

Small business owners who can uphold service standards during the economic slowdown will successfully capture market share. Read more about how to protect your business and personal portfolio during the recession in a recent blog post.

Lease agreements require a long-term commitment and must be scrutinized by small business owners, especially amid the current economic downturn.

Here are some words of advice about structuring a lease agreement:

• Push for a short-term lease agreement if you’re not certain on the stability of your business. You can easily find subleases on Web sites like Craigslist.
• For longer lease terms, negotiate hard with the landlord. Try to bargain two to three months of free rentals with little to no rent escalation at the end of the lease, free renovation and not more than two months of rent required upfront in case of early lease termination.
• Check to see if your business is located in a state enterprise zone. Companies within these areas receive state tax breaks on capital investments and job creation. Use our online tax credit locater tool to find out if your business qualifies for tax rebates.
• Take precautions. Always include a sublease clause in the agreement in case your business must vacate earlier than expected.

Work the recession to your advantage and negotiate the best possible lease agreement. Check out our recent blog post for more information on how to keep your small business afloat during the credit crunch.

Typically, people incorporate their business as an S-corp or Limited Liability Company (LLC) because of the tax benefits. Both structures are pass through entities, where the business income is passed along to the small business owner’s personal income, avoiding double taxation

There are 3 main differences between an S-corp and LLC:

Number of shareholders:

• Under an S-corp there is a 75 shareholder limit.
• There is no restriction on number of shareholders under LLC.

Management Body:

• S-corp is managed by board of directors.
• LLC can be managed by business owner or other management.

Employment/Payroll Tax:

• S-corp owner pays employment/payroll tax on salaries, but there is no tax on dividends to shareholders.
• LLC owner only pays self-employment tax on total net income. (Note: The owner also has the option to be taxed like an S-corp if the case is made before the 16th day of the third month of the tax year.)

However, beyond these direct benefits and limitations, entrepreneurs must strongly consider the long-term growth goals for the company during incorporation. Generally, venture capital firms and institutional investors favor S-Corp business structure. It provides a formal organizational framework and helps create stock option pools for employees.

For more information on how to start a business, check out our recent blog post on the benefits of registering your company with D&B.

Networking can be a life-line for your small business. Choosing the right events and making the right business connections can accelerate company growth. Crain’s offers a great guide for business events in larger cities, organized by industry. However, conferences and expos can be pricey.

Here are some inexpensive alternatives:

• Local Chamber of Commerce
• Industry Associations
• Local Charities
• Minority/Women/Entrepreneurial Associations
• Online Networks like LinkedIn or Ning