‘Growth’ is the fundamental thing that every entrepreneur expects from his business. The growth in any business is the result of a perfect combination of intelligence, manpower, and fund. One can buy the first two if he has an abundance of the last one.
Yes! It is true that money is the lifeblood of any kind of business irrespective of its size or age. A shortage of cash flow can make a business cripple within a very short period of time. If your business is at its initial stage then the risk even becomes higher. So whenever a shortage of fund is foreseen, one must go for the financing of the same.
Financing a business has always been challenging for entrepreneurs, especially if your business is a small business. There are generally two options available to fund a business. The first one is a Debt Financing like a business loan which is very popular among the budding entrepreneurs and the second one is getting a fund by Equity Financing.
The equity financing vs debt financing is the dilemma faced by many small business owners. It is always confusing if one should go for debt financing and apply for a business loan or try to find an investor and avail an equity financing. Read on the comparison below of both financing instruments to determine the best type of financing for your business.
What Is Debt Financing?
A debt financing is a loan taken for a business from an outside entity to fund your business. While availing a fund from any lending institution you make an agreement with the lender to pay back the borrowed money in a fixed number of installments along with the interest. In the terms of banking, such credits are also called as business loans. A lender provides you with a business loan only if the lender is satisfied with your business plan. A business loan provider never takes a share of your profit neither they take a decision on your business. What you only need to pay to the lender is the principal amount, interest and the other fees and charges associated with the loan.
Pros and Cons of Debt Financing
There are a number of advantages you can enjoy when you avail the financing through a debt financing. When you opt for a debt finance, you can control over the fund you have received and no one can impose their decision on you. The impact of a business loan lasts till you pay off the loan. Once your loan repayment is over, you will be the sole proprietor of your asset. Moreover, paying back the borrowed amount is easier as there is a certain amount which you are to pay every month to the lender.
Along with the advantages, some drawbacks also exist in debt financing. A debt financing comes with firm deadlines which must be touched. Failing to pay back the loan amount on the pre-fixed time can make you face legal actions against you. Another point to be noticed that, if you have a huge business loan, it will be difficult to find investors for your business. Businesses are always unpredictable. If it happens that your business has to face a loss, a debt financing will leave your business vulnerable. The next matter of woe regarding a debt finance is being a collateralized loan. A debt financing is secured by the assets of your business. If cannot pay the loan back, the lender may sell your asset to recover the loan amount.
What Is Equity Financing?
The equity financing is shopping for the investors to buy a part of your company. It is like selling shares of your company to investors who would take a percentage of the profit in the future. Instead of paying back the principal amount with interest, the primary owner of the business gives a percentage of their company in return for funding. In this way of financing, one doesn’t need to pay the investors back in regular installments. There are many ways to avail a fund from equity financings such as a private or “angel” investor, a friend or family member, or by selling shares in your business to investors. There are again some professional institutes who work as a platform to sell and buy stocks such as venture capitals.
Pros and Cons Of Equity Financing
Just like debt financing, there are advantages and disadvantages of equity financing too. The most prominent advantage of equity financing is being risk-free. As you don’t need to pay back or none of your assets is collateralized, you take this investment as a risk-free investment. One can even grow a network of opportunities while working with equity investment. Moreover one doesn’t need to channel his profit in loan repayment. If we take the worst conditions when your business fails, you will not be liable to pay any money to the investor.
Now let’s look into the disadvantages of equity financing. The first disadvantage of an equity financing is the less control over the business. when you will share the ownership with a number of people, you are to respect their decisions towards your business too. You will have to consult with the investors before taking any serious decisions on your business. Finding the investor needs lots of time and effort. The task even becomes more difficult if the business is at its initial stage.
How to Choose The Best One For My Business?
The ultimate decision of opting one financing option depends on the type of business you have, amount of money you need and the ability of your business to take risks. If we look from a general overview then it is best to opt for a debt financing. The reason which has made me opt for this option is that you will be the sole owner of the business. If you take a debt financing then you will only be the owner of your property and no one can take shares of your profit. But this concept is not acceptable at all the times.
Here I am focusing on some situation and the ideal financing options for the same
# Situation No 1
If You Need Money for Short Term
It may happen that your business lacks working capital because of offseason and you need financing only till your business catches its growth back. In such situations when you are assured of paying your credit back within a short time, you should better opt for a debt finance. Giving up equity in your business is a big decision and such actions should not be taken for a small amount or short duration.
# Situation No 2
When your Need For Money Is Not Very Big
In such situations, I would suggest opting for debt financing. Sharing the ownership of your business for a small amount is never a good financial decision. If it is a small amount you can easily get a business loan and because of a low amount your risk level will also come down.
# Situation No 3
You Need Money Urgently
If you need money urgently, then once again bank financing is advisable. Searching investors need more time and effort. Being fast in the availing of funds is one of the advantages of debt financing.
# Situation No 4
When You Need Expert Advice Along With Funding
An equity funding comes with the guidance and suggestions of the investors. If your investors are well experienced in their respective field, you will be benefitted by the experience of those persons. If you are expecting such valuable suggestions along with funding then equity financing works best for you.
# Situation No 5
When You Really Dream Big
If you really expect your business to be one of the top businesses of the country, then the step of taking an equity financing is the one which fits your business. When your business has come up with an outstanding concept, it would surely attract more and more investors in the future. If the investment you receive is used in the right way, it is sure to earn big returns in a time frame of three to five years.
The Bottom Line
Whether to choose debt financing or equity financing depends on the kind of business you have or the need for money. No ideal answer to this dilemma of financing options can be given. One has to examine the pros and cons of both financing options so that the best can be chosen for your business.