HOW TO FINANCE YOUR BUSINESS: EQUITY OR DEBT?

By Priyanshi Bansal

Businesses often need money. This is especially true for companies in the beginning stages of development. Finding that money can be difficult. There are two basic types of funding available to small businesses - debt financing and equity financing. As a Business owner, which is best for you?

What Is Debt Financing?

Debt financing for your business is something you likely understand better than you think. Do you have a mortgage or an automobile loan? Both of these are forms of debt financing. It works the same way for your business. Debt financing comes from a bank or some other lending institution. As a business owner, you can apply for a business loan from a bank or receive a personal loan from friends, family or other lenders, all of which you must pay back.

The advantages of debt financing are numerous:

-First, the lender has no control over your business.

-Once you pay the loan back, your relationship with the financier ends.

-Next, the interest you pay is tax deductible.

-Finally, it is easy to forecast expenses because loan payments do not fluctuate.

The downside to debt financing is very real to anybody who has debt:

- Debt is a bet on your future ability to pay back the loan.

-What if your company hits hard times or the economy, once again, experiences a meltdown?

-What if your business does not grow as fast or as well as you expected?

Debt is an expense and you have to pay expenses on a regular schedule. This could put a

damper on your company's ability to grow.

What Is Equity Financing?

The public does not understand equity financing as well as debt financing, because equity financing involves investors. You could offer shares of your company to family, friends and other small investors, but equity financing often involves venture capitalists or angel investors. The big advantage of equity financing is that the investor takes all of the risk. If your company fails, you do not have to pay the money back. You will also have more cash available because there are no loan payments. Finally, investors take a long-term view and understand that growing a business takes time.

The downside is large. In order to gain the funding, you will have to give the investor a

percentage of your company. You will have to share your profits and consult with your new partners any time you make decisions affecting the company. The only way to remove investors is to buy them out, but that will likely be more expensive than the money they originally gave you.

Now the question is "Which Funding Method Should I Choose?"

Often you will not have a choice. Formal equity financing is difficult to secure especially for small, early-stage startups. Venture capitalists are looking for companies with global reach. Angel investors, those who fund on a smaller scale, are often looking to invest a minimum of $300,000 and possibly a 50% stake in the company, especially if it is in the very beginning stages. If your company is a startup serving a local market and does not need large-scale funding, debt financing is probably your best, and perhaps only, option. Larger startups often combine debt and equity financing to reduce the downside of both types.

The Bottom Line

The type of financing you seek depends largely on your startup. If you are just getting started, consider a loan from family, friends or a bank. As you grow and reach a larger market, equity funding may become a more viable option if you are willing to give up a portion of your company.