It is public knowledge that a business without initial investment is a ship ready to sink. Even if the business establisher does not opt for loan or debt, he will have to invest bucks from his own pockets. Now it becomes essential to find a source through which you can produce this money. Debt and equity financing are two of the most cashable ways to acquire the funding for the business.
To begin with, it is essential to know what is debt financing and what is equity financing. Understanding the differences between debt and equity financing will help the business owner to choose the right one for his cause. Here is the complete information focusing on debt v/s equity financing.
What is Debt Financing?
What is debt financing? It runs on a borrow and payback basis. The money taken from the lender along with agreed interest forms the ‘cost’.
The borrowers will then have to pay back in monthly instalments. In case the borrower fails to pay back, the security collateral will be entirely under the lender’s authority as a form of repayment. This collateral can be any form of riches that the lender can exploit to get repaid. Ranging from insurance policies to lands, you can place anything as your collateral.
Small Business Administration (SBA) is a well-known source that lends money to business starters. Bank loans that are often associated with borrowing money come under debt financing too. Credit cards and debit cards act as an alternative source of funds. Fixed monthly payments may or may not be the method of payment for these effective alternatives.
Pros of Debt Financing
It is a widely known form of financing and easily accessible by the initial startups. All you need is proper collateral for reassurance and estimation of repayment.
What you agree on is what you get. The terms and conditions are always before you to study and understand. Nothing changes without the consent of both parties.
The complete authority of the business lies with the business owner, and no form of interference from the lender will be there. This is a significant difference between depth and equity financing.
Cons of Debt Financing
The repayment and interest terms can be unreasonable with higher interests and demand for costly collaterals. Not everyone can meet these needs and get going.
For an initial startup, it can be difficult to make monthly payments within the first month of business establishment. The profits do not roll in so soon, and alternative ways of payments may not be at your service.
In case you fail to have profits that can help you repay, you have to fetch some coins of your own. This can burn holes in a business establisher’s pockets. Not to forget the collateral that you’ll lose. That is the sad reality.
What is Equity Financing?
Equity financing is a harder but safer option compared to depth financing. What is equity financing? This form of financing has individual or several investors buying a portion of the company in return for future profits. The business owner has a majority of the shares on his name and does not have to pay monthly instalments. But the company does not belong to him entirely.
When Angel investors and Venture capitalists are in the picture, they will not invest in businesses that do not generate a fortune later. A business owner must have a proper plan laid out with all the specifics neatly explained and a spectacular team to back him. It should seem like you already know where your business will head and the numbers that it will draw. This will attract Venture Capitalist or angel investor’s interest.
A kind of equity financing that not many know of is equity crowdfunding. It mainly associates with selling a small portion of the business to many investors. The more, the merrier. The terms of equity crowdfunding are mentioned in Title III of the JOBS Act, and it is a well-established form of equity association. However, you should be a pro at convincing those multiple investors to risk their money in your business. You have to prepare yourself to be the best to get the best in the market.
Pros of Equity Financing
Equity financing allows the owner to get large investments and also he doesn’t have to pay back in monthly instalments. Only the profits in the business matter to both the parties. This is a significant pro when debt v/s equity financing is being discussed.
This is the best option for companies venturing into huge arenas like technological sectors and other high growth industries. The investment, as well as the profits, will be high.
Just in case the company fails to prosper, the wrath of loss is shared equally between the owner and the investors.
Cons of Equity Financing
Business establishers should be careful about their share sales. If more than 49% of their shares are sold, they lose their majority say in the company. The other investors can overthrow them and change the ownership if they think it is necessary.
Getting equity financing itself is a challenging job. None of the investors will readily join with companies unless they see the potential. A lot of work and efforts are required to draw investors if you don’t already have your connections.
While you study debt v/s equity financing, several points come forth. Seeing the differences between debt and equity financing, you can make the right choice for your business.
Depending on the sector you want to jump into, approach the proper funding. Knowing what debt financing is and what is equity financing will give you a better insight into the capital and investment areas of your business. Nothing comes without their share of pros and cons. Study them carefully and opt for the one where the best comes to you over time.