When starting a business, most entrepreneurs don’t have all the capital needed to get up and to run. Before obtaining an office or storefront, buying and leasing equipment, furniture, or hiring staff, the owner will need to decide how to raise the required capital. There are two types of financing, debt financing and equity financing.
Debt financing is common when purchasing a home or a car. Debt financing is money that you borrow from an individual or institution to pay back with interest. When you take out any loan, use a credit card or any other financing you pay back at a future date, you are using debt financing. Debt financing does not give the individual or organization loaning you money any stake in your business.
Equity financing is an investment rather than a loan. The individual or organization that provides equity financing will be doing so as an investment. They will become a part-owner or stakeholder in your company. Equity financing can come from investment firms, individual investors, crowdsource investing, or other groups that have identified your business as a good investment. The most common type of equity financing is from friends or family who invest in your business and wait for a return on their investment rather than pay it back as a loan.
Here are some pros and cons of both debt and equity financing to help you decide which options are right for you and your business.
Debt Financing Pros
- Once the loan is paid off, you are free and clear of any obligation to the lender
- The lender has no controlling interest in how you run your business
- It is more widely available in short and long-term loans, inventory and equipment leases, accounts receivable loans, personal loans, and business loans
- Paying off the loan will build your business credit rating, making it easier to obtain financing in the future of your business as needed
Debt Financing Cons
- You owe regular payments immediately upon receiving the loan unless you there is a deferred payment plan in place
- Payments can be paid back daily, monthly, or at some other increment determined by the individual or institution lending the money, which can increase interest
- Failure to pay back the loan or late payments will damage your business credit rating, making future financing difficult or interest rates higher
- It may require you to put up collateral, which can put the property used as collateral at risk if you default on the loan
Equity Financing Pros
- You will not have payments due, which will give you more capital to put in the business
- Business investors can bring with their capital investment their connections and experience, which will help your business succeed
- Investors could invest more in the business if there are difficulties, whereas you might not be able to get more loans
Equity Financing Cons
- Though you are the owner of the business, investors could push you out of your own business at some point if they don’t like your business practices
- If your business fails and the investor(s) do not get a return on their investment, they can take over the business
- Not every business will be able to get equity financing if the business is an investment risk
- Only businesses in specific industries or with high growth potential can obtain equity financing
- You are giving up control of some amount of your business to outsiders and, in some cases, strangers
- If you aren’t able to make a profit quickly, you could lose your business
Conclusion
If you cannot finance your business startup with your capital, you will need to consider debt or equity financing. Weighing the pros and cons and your needs as an entrepreneur, you can make the financing decision that is best for your business.
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