Unless your business has a massive balance sheet, you will need financing at some point. For small businesses, you might have to choose between different financing options, keeping in mind that each of these options has its own advantages and disadvantages. Today, we are going to look at debt financing and equity financing as ways of getting your business off the ground.
A lot of people use debt financing, but they do not know it by this name. Debt financing is where you get a loan as a debt. A good example is an automobile loan. You get the asset and the loaned amount in your hands and then commit to repaying a certain amount per month. This works the same way as traditional loans but with slight differences like the interest on debt financing being tax-deductible, while the interest repaid on a loan is usually not. Applying for debt financing looks a lot like getting a loan in most cases.
Pros and Cons of Debt Financing
When you finance your business through debt, the lender or bank does not have any control over your business. Their control only comes into play if you default on the loan. Second, in contrast to equity financing, your relationship with the bank ends when you finish repaying the loan. Neither of you owes the other anything when this particular arrangement ends.
Finally, you can schedule monthly debt payments, which makes it easier to budget for the debt. Debt repayment, as with getting a loan, requires that you have an assured level of income every month. Relying on debt financing is also very difficult during recessions and harder economic times.
Equity financing involves giving up part of your business for some financing. Investors, sometimes called angel investors or venture capitalists, bid for a percentage of your business and in turn, they give you the cash to get your business off the ground or expand it.
Venture capitalists are usually firms with whole departments dedicated to investing in businesses such as yours, and as such, you can expect extensive due diligence plus background and financial checks to ensure everything is okay with you and the business.
Angel investors are usually wealthy individuals with a keen interest in your business. Angel investors are interested in a single part of a business, which means they move fast and often come with simpler terms than venture capitalists.
Pros and Cons of Equity Financing
The main benefit of equity financing is that you do not have to pay back the money. Because you do not have monthly payments, you will often have better cash flow than businesses that opted for debt financing or a loan. Another advantage is that there is less pressure to grow your business. Banks and other lenders will often pressure you to get your business going as fast as possible so you are able to start making payments. Venture capitalists and angel investors understand the nature of business and give you some breathing space to put everything into place.
Debt financing and equity financing are getting increasingly popular, especially in a world where traditional ways of financing a business are getting less appealing. Both of these ways of financing a business have their own advantages and the one you choose will depend on your business needs and whether or not you want to cede some part of your business.