You may need to look for additional financing at specific stages of your business growth. Most of the time, you will need cash urgently when experiencing growing pains. The reality on the ground is that getting money for small businesses is difficult. Tighter lending rules from banks and traditional lenders and a scaling back from investment by angel investors has left small businesses nearly unable to secure financing.
Small businesses can take advantage of different types of financing options. The most common ones are equity financing and debt financing. It’s important to know the difference between the two financing options to know which one will be suitable for your business.
Overview of Debt Financing
When you select debt financing, you are simply getting a loan that will have to be paid back with interest. Buying a home, a car or using credit card are common forms of debt financing. You can take a loan from a bank, family members or friends and pay it back with interest.
There are many reasons why you may want to choose debt financing for your business. To begin, the lender has no control of your business. Your obligations with the lender will end as soon as you pay back the loan with interest. Another good thing is that any interest you pay on the loan is tax deductible. Finally, you will not be stressed to pay back the loan since the payments are required in regular installments. This makes it easy for you to plan your expenses over time.
How Does Equity Financing Work?
Unlike debt financing, equity financing is not well understood. Investors are involved in equity financing and this is why it is not as popular as debt financing. While your family and friends may hold shares of your company, equity financing usually involves angel investors or venture capitalists.
With equity financing, the investor takes all the risk of the business. In case your business does not end up breaking even, you will not have any money to pay back. Moreover, through the financing, you will have more cash at your disposal since there are no loan payments to be made. Finally, venture capitalist can provide you with advice and a platform to launch your business globally.
Which Funding Option is Ideal for You?
In most cases, you will not have a choice when it comes to funding. Getting formal financing can be quite difficult if you are running a small business. On the flip side, unless your business has the potential for a global reach, getting venture capital will be nearly impossible. To get funds from angel investors, you will have to give part of the ownership of your business.
The above is a summary of how equity and debt financing work.