Business financing isn’t a simple topic that can be described by loans alone. The best financing options for a business are often varied. Most companies use a combination of debt financing and equity financing to fund their business expenses.
Each form of business financing carries its benefits. Of course, each option carries costs that must be considered before you borrow money.
Debt financing is an option that more people understand. It’s the kind of financing that you take out with a personal loan. You apply for a loan, you get your funds, then you pay them back as per your agreement with the lender.
Debt financing is a broad subject. There are many types of loans and you use them in different ways. However, no matter which kind of loan you use, the concept remains the same. You don’t have to give up a piece of your business to take advantage of debt financing.
Because debt financing can be taken in so many ways, it offers you more flexibility. If you’re having trouble keeping up with inventory, there are specific loans for that. If you just need to buy a new truck, there are also loans for that. You can take advantage of the wide range of deals available to you.
Equity financing describes the option of raising capital by selling shares. A company can sell its shares to raise funds rather quickly.
Speed and the freedom to operate at your own pace are among the key benefits of equity financing. However, a potentially stronger benefit is that unlike debt financing, equity financing won’t lead to you making payments. Because you are selling company shares, you don’t end up owing anyone money (for now). You are just selling ownership in your company in exchange for cash.
Where Does Equity Funding Come From?
You can raise equity through one of several methods. Family, friends, and members of the local community are places to start. For large companies, launching an Initial Public Offering (IPO) is a feasible way to gain funding. Large companies like Google and Microsoft made billions during their IPOs.
Equity financing is often associated with large, public companies. The truth is that private companies can also benefit from equity financing.
Several components can be sold as equity financing:
- Common equity
- Preferred stock
- Common shares
- Common warrants
· Common equity
Any startup that sees success and evolves into a larger company will find several sources of equity. The equity financing that is available to startups will evolve as it grows. When a startup is gaining traction, investors will lean towards convertible preferred shares. Once a company grows larger, it will often consider selling common equity.
The initial control and lack of necessary repayments may seem great at the start. However, there are several drawbacks to equity financing. Eventually, you will have to pay your investors back. The good news is that you’ll only need to do so if your company becomes profitable. You won’t have to make regular, timely payments like you would with a debt financing option.
Once you’re making a profit, you must pay the investors the amount you previously agreed upon. The downside is that you’ll have to do this for the entire life of your business. At this point, the only way to avoid having to pay your investors is buying them out. Unfortunately, this is usually only possible if you’re making an extraordinary amount of money.
What’s The Difference Between These Financing Options?
So, while both options sound similar there are a few differences:
· Debt financing requires you to make timely payments right away. Equity financing does not.
· Debt financing carries interest costs. Equity financing does not.
· Equity financing requires you to sell partial ownership in your company. Debt financing does not.
· Equity financing requires you to pay a portion of profits to investors indefinitely. Debt financing does not.
What Are The Best Financing Options For A Business?
In general, debt financing is easier to acquire and offers you more freedom. Debt financing options are usually the best financing options for a business. It’s a flexible category that allows you to, with some exceptions, spend the money the way you decide to. It also won’t cause you to lose control over how your business is run. Debt financing allows you to continue to do business on your terms alone.
For most situations, debt financing is preferable. You do lose out by having to repay more than you borrowed. However, if you’re wise with your loan, you should end up making a return on investment in the long term.
This isn’t to say that equity financing is inferior across the board. If fact, it can be preferable in many specific situations. The main downside is the control you lose over your business’s future.
There are still other benefits to equity financing that we haven’t gone over. There is a long-term benefit to the relationships you build when taking advantage of equity financing. If you land with good investors, you can learn from them and pick up lessons about business that last a lifetime.
Should your business fail, equity financing carries the fewest consequences of the two categories. Planning for failure isn’t a good idea. Still, you might find it less stressful when you know you won’t be required to pay your investors back should things go south.
Both debt and equity financing have a place in the business world. It’s up to you to decide which one is best for your business. For the most part, simple debt financing options will be the easiest to understand and handle. However, you should never rule any single option out when you’re working to grow your business. The best financing options for a business are the ones that propel your business forward.