Money is the lifeblood of business. From building your initial capital investment for the launch of your company, to managing revenue and your accounts payable successfully, finance management as a whole is a cumbersome task many entrepreneurs are not prepared to take on.
That said, the modern business world is not scarce when it comes to financing options, of which debt and equity financing present the most viable opportunities every aspiring entrepreneur should take into consideration before starting a business.
Let us break down the two and present a case for both options in order to give you a comprehensive overview of your financing solutions and help you make the best cost-effective decision for your company.
What is Debt Financing?
In a nutshell, debt financing means borrowing money from a lending institution, such as a bank or a private lender. There are a number or borrowing options available for new entrepreneurs, ranging from investor lending to lines of credit, using hybrid convertible notes, and opting for working capital loans.
Some entrepreneurs even opt for using their own personal line of credit to kick-start their company, however, this is an option that is oftentimes discouraged by seasoned business leaders simply due to the increased volatility of the investment. After all, the saying goes that you shouldn’t mix your personal life with your business life, so why would you risk your own livelihood?
The Pros of Debt Financing
There are certain distinct advantages to choosing debt financing instead of equity financing (more on that in a bit), but one of the most notable pros is the amount of control and ownership that borrowing money provides.
Unlike equity, financing that gives a certain amount of control over to the stakeholders, taking out a loan means that you will retain complete control over the company. In highly competitive regions of the world such as Australia, for example, this becomes very important.
In the Land Down Under, the business world is dominated by loans, with the majority of up-and-coming companies opting for flexible business loans across that allow for scheduled repayments per the client’s capabilities.
Following the same mindset, you should search for lenders with flexible loan terms and reasonable interest rates if you choose to follow the path of debt financing. While it is one of the most reliable forms of financing in the business world, be sure to take the necessary precautions before you apply for a loan.
If we continue to follow the example of the Australian business scene, we should note that more than 40% of new companies opt for debt financing, but how many of these startups will be able to repay their loans per the terms and conditions of their agreements? This is the biggest downside of debt financing, which should not be a problem if your company is operating somewhere in within your projected revenue margins and is able to repay the debt in the pre-agreed installments.
On the other hand, if you are just burning through your loan without actually gaining money, then you could get in trouble with your lender – not just now, but in the long run as well. You will need to ensure a steady rise to a positive ROI, and quickly, if you are to repay your loan, ensure future capital availability, and safeguard your business against negative valuation in the long term.
Equity Financing Explained
To keep it simple, equity financing means that you are raising funds from investors in exchange for company shares, or more concretely, ownership interest. Your investors could be friends or family members, or even whole angel investor groups specializing in aiding the birth and growth or promising business ventures. With that in mind, let us assess the pros of investing capital and equity finance.
The Pros of Equity Financing
The biggest advantage of attracting investors is that there is virtually no limit to the investment amount. Investors can choose to aid your business venture however, they see fit, and if you get enough people on board to support your idea, you could obtain the necessary funds to not only launch your company, but also develop it to its full potential.
Another benefit of not having to repay a loan is that your investors, or shareholders, will also be working towards making your company a success. After all, it is in their interest. With their ongoing support and even professional guidance, you may be able to realize your entrepreneurial dreams faster.
The Cons of Equity Financing
However lucrative the opportunity may seem, equity financing is not without its downsides. Firstly, and most importantly, you could be looking at a loss of control. Your plan for the growth and expansion of your company might get overruled by the board of investors and your company might take a different path, so be careful as to how much control you will give them.
Secondly, keep in mind that while you do not have a debt to pay off, your investors will be taking a sizable percentage of the revenue for themselves. Moreover, investors will oftentimes put themselves first, which means that you will be the last in line to enjoy a slice of the revenue. Lastly, know that equity financing is long and arduous, and that there is no guarantee that you will be able to get enough affluent investor on board.
Both equity and debt financing are popular solutions for aspiring entrepreneurs looking to get their companies off the ground. That said, there are distinct differences between the two, so be sure to use this guide in order to determine the best option for your specific situation, and thus pave the road to security, solvency, and success in the business world.