How to Finance Your SME: Debt or Equity?
As a small business owner, you know that it’s hard to gain business capital. But, you need money to grow your business. Whether you are looking for a startup or expansion funds, you usually have two options: debt financing vs. equity financing. Know the difference between equity and debt financing to choose the right one for your company.
Debt financing is the relationship between the business and a lender where you borrow money and pledge to return it back along with the agreed interest. In this case, you don’t share a part of your business with anybody and remain the sole owner of the business. Once, the amount is paid back to the lender, the relationship ends.
Advantages of Debt Financing
- No dilution of the ownership
You remain the only owner of your business and don’t share it with anybody
- A temporary relationship
On the repayment of the loan, the relationship with the lender ends.
- Easier to plan It is easy to predict figures as loan payments never get fluctuated.
- Online Lending With online loans, you can go online and in a very short easy process get quotes from various lenders. There are few great platforms out there that offer a quick response and a way to go in and put a small amount of information to get a yes or no from these lenders.
Disadvantages of the debt financing
- Timely payments: Money is paid in fixed monthly installments
- Difficult to qualify for the loan: Depending upon the credit history and score, it is a bit difficult to qualify for the loan you want
- Increases business vulnerability: Debt financing leaves the business when there is a dip in sales
- Collateral: In case of non-payment of the debt, the assets of the company may be held as collateral by the lending institution
Equity financing involves angel investors or the venture capitalists with which you trade ownership of your company in return for their capital. It is these investors who invest their money in your business and reap benefits in case of profit.
Advantages of equity financing
- More cash flow: There is availability of more cash capital as you don’t have any loan to pay back
- Long-term view: The investors usually take a long-term view and understand the fact that return on their investments will take time
- Flexible: Equity payments tend to be more creative and flexible as compared to the debt loan.
Disadvantages of the Equity Financing
- Less control: As you share ownership of the company, the investors seek ownership and part of the profit
- Takes a longer time As compared to the fast debt financing options available, equity financing takes a longer time
- More research You have to invest time in searching for the right investors for the company
- Total cost The total cost involved in the equity financing is much more than paying a loan
Choosing between debt and equity financing
- How much is the capital requirement?
The foremost thing to be evaluated is the exact capital requirements. As, knowing this will make the task of selecting the right financing much easier. If you don’t need a lot, or you’re only looking for a small amount, then debt financing is the better choice. Equity financing rarely comes in small amounts, but you could get business loans for as little as $10,000 or less. Even if you’re looking into early-stage investors, they’ll often look to spend $300,000 or more -- in return for as much as 50 percent equity. But if you could use more cash, like hundreds of thousands or even millions, then again, either debt or equity could be right for you.
- How soon you need the finances?
If the cash requirement is urgent or within a few days then, debt financing is the best option as you get it as soon as possible but if you have some time then, you should wait and go for either of the option.
- Is it okay with you to share your business?
If you are going for equity financing then, you must be sure of having absolutely no problems in sharing your business with the investors. Some entrepreneurs want to control their business single handedly and in such cases equity financing should never be opted for.
The right funding option is different for every business owner when it comes to equity financing vs. debt financing. Often, new small businesses struggle to get equity financing, so they must take on debt. Established businesses are usually able to get a wider variety of financing options. For lenders and investors, providing financing comes down to risk vs. reward. If you experience small business bankruptcy, debt holders have priority over equity holders for recovering funds. Investors have a greater risk, and they expect a larger reward.
You can use a mix of debt and equity financing to lessen the disadvantages of each. By using both options, you reduce the amount of debt you owe and business ownership you give to investors.