It’s no secret that finding the necessary funds to launch your business is no easy feat. It is an overwhelming challenge that almost all businesses face at one point or another. Nowadays, having a billion-dollar idea is not enough. When it comes to starting a business, you should also have a bit of know-how when it comes to the various financing options that are available for you and your business.
While securing financing for your business is difficult, it’s certainly not impossible. If you are a small business owner, there are two main financing categories that you should know about, debt financing and equity financing.
What is debt financing?
Debt financing is funding that you borrow from a financial institution to be paid at a later time. Before you get approved, you would have to establish an agreed-upon interest in addition to the total amount that you are planning to borrow. Much like other types of financing, debt financing is a time-bound financial obligation that you need to pay back over a set period of time. Some of the most common debt financing examples include:
- Traditional bank loans
- Business lines of credit
- Credit cards
- Cash flow loans
- Government-backed loans
In debt financing, payments are usually made through monthly installments until the borrowed amount has been paid in full. However, it is important to note that loan term specifics would depend on the borrower’s financial standing and the type of debt financing that they are applying for. To determine if debt financing is right for your business, let’s take a look at some of its advantages and disadvantages.
What are the advantages of debt financing?
- Business owners can maintain full control of their business
- Predictable monthly payments
- Costs associated with interest payments are tax-deductible
- Debt financing can improve (or build) your business credit score
- Debt financing, if used properly, can foster business growth
What are the disadvantages of debt financing?
- Long-term debt financing usually require collateral
- Debt financing can be difficult to acquire
- Your business assets can be seized in case you default on your loan
- Debt financing can test your restraint and financial discipline
- Making payments can affect your overall cash flow
It’s a common misconception that going into debt to start a business is a bad thing. While understandable, it’s not necessarily true. As a responsible business owner, it is imperative for you to study each option to determine the type of loan that would best meet your needs.
What is equity financing?
Equity financing refers to the process of raising capital through the selling of shares of a company to investors. As opposed to debt financing, companies that use equity financing are not obligated to pay back the funds provided by investors. Rather, investors are compensated if your business succeeds and you start turning a profit. Equity financing requires a mutual agreement between a business and its investors on a set number of shares in exchange for providing capital. Typically, a larger investment means a larger stake in your business.
Hold on – we know what you’re thinking. What if investors provide more capital to obtain control of your company? If you want to maintain ownership, you would have to ensure that you at least own 50% of your company.
What are the advantages of equity financing?
- You have don’t have to make monthly payments towards a loan
- Equity financing enables you to learn from your partners
- No interest payments
- No liability in case the business does not succeed
- Equity financing gives businesses the flexibility to plan for long-term growth
What are the disadvantages of equity financing?
- Investors will expect a share of your profits in exchange for their investment
- Equity investors own a portion of your business which could affect its overall trajectory
- Attracting investors can be a difficult undertaking
- Equity financing requires a lot of planning and could prove to be costly
- Since you are selling ownership, there could be a potential for conflict
What are the key differences between debt and equity financing?
At its most basic, the biggest difference between debt financing and equity financing is business ownership. With debt financing, you borrow money from a financial institution and pay it back with interest. On the other hand, equity financing involves selling stake or ownership in your company to secure financial backing from an investor. To better differentiate one from the other, here are some of the key differences between debt and equity financing:
- Debt financing is usually seen as a short-term solution for businesses that are struggling to improve their cash flow. Meanwhile, equity financing offers a funding solution that would give businesses the flexibility to scale long-term growth.
- Debt financing is usually seen as a riskier option for businesses as payments must be made regardless of cash flow health.
- The main advantage of equity financing over debt financing is that there is no liability to pay back investments in case your business goes under. However, companies that use equity financing are obligated to pay investors dividends when the company makes money.
- Investors or equity shareholders enjoy voting rights and have a say in the trajectory of your company while lenders do not.
Is debt financing riskier than equity financing?
As mentioned above, equity financing is typically seen as a less risky option because you don’t have to put up collateral or maintain regular payments to a financial institution. However, if you’re seriously considering equity financing, it’s important to consider that your investors are entitled to a share of your profits when your business starts making money.
Debt Financing vs Equity Financing: Which is better for your business?
The simple answer is it depends. There is no rule of thumb when it comes to finding the right funding option for your business. The truth is that the best financing option for you depends on what you need and what you can afford to repay.
For instance, equity financing may make more sense if you’re just starting out and are unable to qualify for other more traditional business loans whereas debt financing may be better for businesses that have strong financials and are more established.
Are there other alternative financing options out there?
What if we told you that there is another option out there for your funding needs? Retail businesses, small business owners, and anyone starting a business would benefit from checking out Kickfurther. Kickfurther is an online inventory financing platform that provides companies the funds that they need without reaching out to traditional funding sources. Kickfurther applies a unique twist to the crowdfunding phenomenon for businesses that want to raise money to purchase additional inventory.
Here’s how it works:
- Businesses create accounts and are thoroughly vetted by Kickfurther
- Once approved, Kickfurther’s community funds most deals within a day
- The Kickfurther community pays a business’ manufacturers to produce inventory
- Businesses then outline their expected sales periods to develop customized payment terms
- At the end of each sales period, businesses are required to submit sales reports and provide payment for each inventory sold
- Once payments have been completed, businesses can go through the process again
Kickfurther is a great financing alternative that allows businesses to pounce on growth opportunities and bulk discounts. It also gives businesses the flexibility to maintain their cash flow and explore expansion opportunities without having to worry about monthly payments.
At the end of the day, the financing option that’s best for your business depends on what you need. It’s important to find the balance between the pros and cons of various financing options to make sure that your company will reap the rewards in the long run. Once you understand what you need, you can choose a financial product that would ensure your long-term success.