Obtaining funding is a tricky process that almost all business owners face at some point. When looking for ways of raising capital, there are generally two sources – debt and equity financing. You can try both options, but you should first learn about their differences, disadvantages, and benefits. To make the right decision, there are numerous factors to consider including how much debt the company already has on its books, the predictability of the company’s cash flow, and how at ease the owner is with collaborating with others.
The key distinction between debt and equity funding is whether or not the company owner pays for it. Debt financing entails an investor repaying the money he owes for a long period of time, including interest. There are no repayments for equity funding since the business owner gives up a share of his company to the lender in return for the money.
When someone (family and friends, venture investors, corporate angels, or public floats) invests money or assets in a business in return for a share of ownership, this is referred to as equity financing. As a result, your business’s founder owns a portion of your company and shares in your income. This type of funding is ideal for business owners who are willing to take risks.
Borrowing money to fund a company’s activities and development may be the best option for a business owner under some circumstances. In that case, the owner does not have to relinquish control of his company, but too much debt can stifle its growth. Bank loans, mortgages, and credit cards are all popular forms of debt financing. This could be an appealing choice for business owners that prefer to keep complete control and ownership over their business operations, without having to manage the expectations of investors.
For a start-up or a new business, commercial banks usually look for some sort of collateral and require you to put in pledge your personal assets before they will give you a loan, and in case your business succumbs, you will lose your personal assets.
You should think about these four factors before deciding which choice is best for you and your business, as the choice will largely depend on your situation (factoring in your financial capital, potential investors, credit standing, business plan, tax situation, the tax situation of your investors, and the type of business you plan to start):
Remember that your business’s cost of capital is determined by the combination of debt and equity funding you use.
Regardless of your financing options, the process of raising capital begins with your preparing financial statements and a business plan to take to lenders or stakeholders (read our previous blog ‘Funding Your Business: Find an Investor. You can prepare these documents yourself, but it’s a good idea to use a business planning software like Planium Pro to assist you with the structure and layout of the business plan. Register today for a 14-day free trial to the benefits of using the Planium Pro software.