Small Business Funding Need to Know Information for Small Business Owners
Whether you're planning to launch a startup or want to expand your business, you are going to need money. Debt and equity financing are two different financial strategies you can opt for. Incurring debt entails borrowing money for your business, whereas gaining equity means injecting your own or other stakeholders’ cash into your company.
Quite a few business owners are reluctant about borrowing from a financial institution, as it means cut in cash
profits. But it could be a good option so long as you have sufficient cash flow to pay back the loans, plus interest.
Small business owners often opt for equity financing because they are not sure about qualifying for a loan, or they don’t want to part with cash profits to service the repayment. Investors and partners can provide equity financing.
Advantages of debt financing:
• You do not have to part with any ownership or future profits of your business. Your lender has no control in how you run your business.
• You can keep your business profits in the company, and enhance the long term value, or use those profits to pay a return to the owners of the company.
• You can avail tax deduction on interest paid.
Disadvantages of debt financing:
• You have to maintain sufficient cash flow to repay the loans.
• You will be using your cash profits to pay back the loans. You may earn profit but there won’t be cash to show for it.
• The riskier the loan is, the higher the interest rate will be.
• You might have to furnish some sort of guarantee as owner of the business.
• Lender has rights to seize your collateral, in case of non repayment.
• Too much debt might affect your credit rating and your ability to raise money in the future.
Advantages of equity financing:
• Equity contributions do not have to be paid back even if your company goes bankrupt.
• Your business assets do not have to be pledged as collateral to obtain equity investments.
• Businesses with sufficient equity will look better to lenders, investors and the IRS.
• Your business will have more cash available because it will not have to make debt payments.
Disadvantages of equity financing:
• You will have to part with some of the ownership stake, and your business’s profits will be shared by other equity investors.
• You might have to contend with different ideas on how to run the business.
• No tax deduction on dividend payments.
Most businesses have a mix of debt and equity financing. Too little equity could prevent you from securing or repaying loans, while carrying little or no debt could indicate that you are too risk-averse, and that your business might not grow as a result.