Your small business would be requiring additional capital. Are you thinking of taking out a business loan or are you looking for an investor? Determining how best to arrange finance for your small business is certainly a significant decision that could have huge repercussions. Which would you choose between debt and equity? Let us explore the features, pros, and cons of both debt financing and equity financing so that you could figure out what works best for your business.
What Do You Understand By Debt Financing?
Debt financing involves borrowing money from any lender and ultimately, repaying the money borrowed along with some interest. Taking out a loan is actually debt financing.
Case in Favour of Debt Financing
With debt financing, you are in complete control of the way the additional capital or the borrowed amount would be spent. Sometimes, some lenders may end up imposing specific restrictions but in majority of the cases, you are the chief decision-maker over what you are actually financing. You are the key decision-maker.
Debt financing does not leave a long-lasting impact on the way your small business is going to be operated except for the loan payments that you require to pay off as per agreed schedule.
Debt financing is supposed to be flexible and you have access to a wide variety of business loans varying in terms of the amount of money you could take out as a loan to the time period involved while you make all your repayments.
Why Debt Financing May Not Be a Good Option
Depending on your financials and precise credit scores, it could be pretty difficult to qualify for specific loans of choice. Moreover, in case you are not able to repay your loan, all your business assets could be seized by your lender as per the agreed terms.
What Does Equity Financing Entail?
Equity financing involves trading ownership of your small business to venture capitalists or angel investors in return for the capital provided by them. It is well-known that equity is vital to certain industries and types of business such as startups, as well as, companies having global aspirations.
Case In Favour Of Equity Financing
You would not require paying interest on the capital raised by you as such; you do not require diverting your business profits into repayments. You would, therefore, be left with more capital that could be used for the further growth of your business. Moreover, in the event your business fails, it is not necessary for you to repay investments.
Why Equity Financing May Not Be a Great Choice?
Equity financing is time-consuming as compared to the few fastest debt financing choices available and you get the capital after a long tussle. Moreover, you are required to hand over ownership of your small business along with the decision-making authority and power. You would require consulting with investors and even though you disagree about the future path your business would be taking, you have not much say about it. You may even be compelled to cash out. You may even be forced to abandon your own dream business.
Which Is the Right Choice?
Here are a few questions that you need to find answers to if you are confused about what could be the best thing for your business, debt or equity.
- How urgently do you require the loan?
If you require cash at the earliest, then debt financing should be your right choice. If you are not hard-pressed for time and are not in a great urgency to take out the loan for your business, you may opt for either of the two as both options would work fine for you.
- How Much Loan Amount You Require?
If you do not require a tremendous amount of money and are happy with a small loan for your small business then debt financing is your right choice. This is simply because equity financing very rarely funds small amounts.
- Are you thinking in terms of something more than money?
If you are thinking in terms of establishing a relationship apart from borrowing money from the lender, you must choose equity financing. Debt financing is not the right choice for you then as it is purely transactional. You would be borrowing a certain amount and you would need to pay it back. But equity financing would allow access to contacts, knowledge, and expertise. You could develop a robust relationship that could have a phenomenal impact on your business.
- Would you like to share your own business?
You may prefer to keep your business to yourself only then equity financing is not the right choice for you.
- How big are your business aspirations?
Venture capitalists and angel investors are looking for companies who are having the potential for growing into global businesses or national brands. If you are thinking on these precise lines then equity could be your right choice. But if you are happy to stay small and operate a local business since you appreciate autonomy, individuality, and community aspect, debt financing should be your right choice.
Determining the best financing option could be a big deal for you and it could be having a long-lasting and penetrating impact on the way your business would be running. You must not completely give up the idea of mixing both equity and debt financing depending on your precise requirements at the time. A lot of businesses could be using both.