As a small business owner, you’re constantly faced with finding ways to finance your venture. Even if the company is profitable, there will come a point where it will need to bring in outside money to fund its operations. For instance, if the business is launching a new product line, or perhaps they need to service some debt, they will often require external financing.
At this point, you’ve got two primary choices to finance the business — with debt or with equity. Each option carries its own pros and cons, so it’s important to not blindly follow the herd. Just because your entrepreneur friend used debt financing to scale his business doesn't automatically mean it would work the same for your business.
Let’s break down each one, so you can have the facts before making such a critical decision.
Equity means ownership. In this type of business financing, you’re fundraising by selling part ownership of your company to investors. Every publicly-traded company with a ticker on the stock exchange got there through equity financing.
Other potential sources of equity financing include crowdfunding platforms, angel investors, and venture capital firms. These are private investors, usually institutional and therefore have deep pockets to buy ownership in successful businesses.
The main advantage here is that you are not obligated to repay the investors’ money acquired through equity financing. These investors now own a part of your company and have a say in business decisions going forward. But more importantly, they now share in the risks and rewards of the venture.
With no monthly repayments, the company has more capital at its disposal to fund its growth and tap into new opportunities. The amount obtainable from equity financing is generally higher than you would get with debt financing.
You also enjoy the benefit of a wealth of experience and strategic connections from the investors. These will be most useful in fending off competitors and surviving economic uncertainties.
If you’ve built your business from the ground up, there’s this emotional attachment that comes with it. The thought of giving away a portion of ownership can be a hard decision to make.
You were used to making all the decisions and mapping out the vision for the business, but now you have to include these other owners in your thought process. In some instances, the investors can gain a controlling stake in the company, taking over your decision-making control.
A split company ownership also means that your company profits will have to be split among the owners.
This is when you borrow money to fund your business. Lenders typically range from banks and financing companies to fellow businesses and private investors. So you get the capital while still retaining your 100% ownership of the company. Of course, you’ll have to pay off the loan plus interest over an agreed period.
In most cases, the lender will require collateral against the borrowed amount, or a guarantor assuring the borrower’s fidelity. Some of the most common types of debt financing include account receivable loans, SBA loans, purchase order financing, working capital loans, and unsecured business credit lines.
Being able to raise much-needed capital without ceding control of your company is a huge advantage. Plus, once the debt is fully repaid, you never have to worry about it again.
Debt financing also is a great way to quickly raise money for short to medium term business needs. The capital is quicker to obtain and doesn’t usually go through the same amount of scrutiny that equity financing puts companies through.
If you’ve got a good financial record, you might be able to negotiate for more favorable interest rates so you can minimize your monthly repayments.
Debt must be repaid. The terms of the agreement do not care if your business is doing financially well or not. You are obligated to fulfill your end of the deal to the letter. Defaulting will cost you in the form of late payment fees, increased rates, and a soiled reputation among lenders.
These repayments will put a heavy strain on your company’s finances, limiting working capital and potential profits. Worse, it will restrict its capacity to expand and take advantage of new opportunities until the debt is paid.
Should you borrow money or raise funds through outside investors?
Ultimately, you get to choose which one best serves your company’s needs at the time. With that said, if you’re looking for cost-effective business financing, NTIB Finance & Consulting can help. We provide a lineup of funding programs tailored to suit your business’s requirements.
Talk to us about financing your business today. Give us a call at 914.419.3059 or reach us through our contact form to get started.