As an entrepreneur, there are many financial options to consider; and understanding how to finance your business is an important decision that can have major consequences. So your small business needs extra capital to execute a development project, should you take out a business loan or seek for funding from an investor?
Which is the better option – debt or equity?
Debt financing entails borrowing money from a lender that you’ll eventually pay back with interest. If you have ever taken a loan, you’ve financed something with debt. Armed with a business loan, you’re in control of how that extra capital gets spent. Some lenders impose certain restrictions but in most cases, what you’re financing is completely up to you. Debt financing can be flexible. There are different types of business loans, which vary based on how much money you will get and how long you will make repayments for.
Meanwhile, depending on your credit score and financials, it can be tough to qualify for the loan you want. If you fail to repay the loan, the lender could seize your business’ assets.
Equity financing embroils trading ownership of your business to angel investors or venture capitalists, in return for their capital. Equity is especially important for certain industries and businesses such as tech start-ups and companies with global aspirations. Almost $60 billion in venture capital was invested in the United States in 2015.
You don’t have to pay interest on the capital you raise, so there’s no need to put your business’s profits into debt repayments. This implies you’ve got more cash available to grow your business. With the right investors, you can get great experience, wisdom, industry connections and much more. These relationships can last you a very long time.
However, it takes a long time, especially when compared to some of the fastest debt financing options out there. Equity financing means you will have to give away ownership of your business and also some of your decision-making power. You will also have to consult with the investors over the strategic direction of your company. In some extreme cases, you may be forced to cash out and abandon your own business.
How do you know which of these options best suits your business? If you require funds urgently, then debt financing is the way to go. Meanwhile, equity financing involves finding the right investors, pitching your business, drawing up the legal documents and more. If you are searching for a small amount of capital, then debt financing is the better choice. Equity financing rarely comes in small amounts, but you could get business loans for as little as $5,000 USD or less.
However, if you need more than just money, equity is probably for you. Debt financing is transactional. You borrow, and then you pay back what you owe plus interest. Equity will give you access to an investor’s knowledge, contacts and expertise. You get to establish a relationship that could have a positive effect on your business, as long as you’ve partnered with the right people. If what you want is more cash in your bank account, then it might be best not to get involved with investors.
Finding the right kind of financing is a big deal, and it can have a deep and lasting effect on how your business operations and sustenance.