Deciding if you are going to take out a loan for financing your small business, or if you are going to opt for equity financing, is quite a challenge. It is quite obvious that, if you are going to start a small business, you would need lots of cash. Even if you are planning to expand your business, you would need enough cash. So, you will ultimately be required to decide, which would be the better option for financing your business.
Debt financing versus equity financing
In order to decide if debt financing would be the better option for you, or if it is equity financing, you will have to understand the difference between the two options.
Debt financing – Advantages and Disadvantages
Advantages to debt financing:
- The lending institution isn’t supposed to have any say with regards to how you are going to run your business with the payback, all of the obligations are over
- The interest is tax deductible
- Both short term and long term options are there
- You can budget your payments as the amount owed is known
Disadvantages to debt financing:
- Money is to be paid back within a fixed term
- You can have problems in paying the loan back
- If you have too much of debt, you may have problems in getting cash through equity financing too, in the future
- Debt can create problems with regards to the growth of the business
- Business assets can be used as collateral
Equity financing – Advantages and disadvantages
Advantages to equity financing:
- Equity financing is less risky as you aren’t required to pay back any money
- You can tap into the network of the investor, and this helps in adding credibility towards your business
- Investors in general do not expect quick returns on the investment, but think on long term basis
- You need not think about channelizing the profits towards any repayment
- You may be able to have greater cash in hand for expansion purpose
Disadvantages to equity financing:
- The rate of returns may be more than the rate of a loan
- The investor based on the investment can have part of the ownership to your business
- Because the investors have ownership of the business, you may be required to consult the investors before taking the decisions
- Some irreconcilable disagreements in between you and the investors can arise. In such situations, you may be required to cash in the portion of your business which is in your name. as a result, you will be required to allow the other investors to run the business without you having any role in it
So, here are the different advantages and the disadvantages of the two different forms of financing options. You will be required to weigh the pros and cons of both the options, and decide which would be the best option for you.
Written by Sophia Stewart Garfield.