Weighing Your Options: Debt or Equity Financing?
When it comes to financing your business some hard decisions will need to be made. Do you want to bring your business into debt to get the funds that you need to grow your enterprise or will you relinquish a percentage of your control to take your business to the next level?
The first move in either regard is to ensure that you are making an informed decision and that you truly understand the potential repercussions and disadvantages of either option. But what are debt and equity financing and how can you determine which is best for your business? Backd is here to help you make an informed decision with our direct comparison of debt and equity financing.
Equity Financing
Equity financing is a method of raising capital for your business by selling a percentage of your ownership, in the form of shares, to investors. In equity financing, investors provide funds to the company in exchange for a percentage of ownership, also known as equity, in the business.
Equity financing can be used by both startups and established companies to raise capital for various purposes, such as expanding operations, developing new products, or paying off any debt that the company may currently owe.
The investor, or investors, who provide equity financing typically receive a share of the profits, known as dividends. They may also have a say in the company’s decision-making process, depending on the terms of the agreement.
Equity financing can be directly contracted with debt financing, where a company borrows capital from lenders and pays it back with interest. Unlike equity financing, debt financing does not involve selling ownership shares, and lenders do not have a say in the company’s decision-making process.
Pros
No Debt Repayment: Equity financing does not require repayment of the invested amount as it is not a loan. This reduces the financial burden on the business and allows it to focus on growth and expansion.
Access to Expertise: Equity investors often bring valuable expertise, experience, and connections to the business, which can help in the growth and success of the company.
Lower Financial Risk: Since equity financing does not require collateral or personal guarantees, it reduces the financial risk for business owners.
Flexibility: Equity financing offers flexibility in terms of how the funds can be used, and there are no restrictions on the use of capital.
Cons
Dilution of Ownership: By selling ownership shares, the business owners dilute their ownership in the company. This means that they give up control over the decision-making processes and may have to share profits with the investors.
Higher Cost: Equity financing is typically more expensive than debt financing, as investors expect a higher return on their investment to compensate for the higher risk.
Time-Consuming: Equity financing can be a time-consuming process, as it involves finding investors, negotiating terms, and completing legal and regulatory requirements.
Risk of Conflict: Equity investors may have different goals or expectations for the business, which can lead to conflicts with the management or other investors.
Debt Financing
Debt financing is a method of raising capital for a business or organization by borrowing money from a lender or investor, with the agreement to repay the borrowed about plus interest over a specific period of time. This can be in the form of bonds, loans, or other debt instruments.
In debt financing, the borrower (the company or organization) is legally obligated to repay the principal amount of the loan, along with interest and other fees, in line with the terms and conditions of the agreement. The lender, in turn, receives regular interest payments as well as the repayment of the principal at the end of the term.
Debt financing is often used by companies and organizations as a way to raise capital for various purposes, such as funding new projects, expanding operations, or refinancing existing debt. However, it also carries the risk of default if the borrower is unable to make the required payments, which can result in penalties, higher interest rates, and damage to the borrower’s credit rating.
Pros
Lower Cost of Capital: Debt financing is usually cheaper than equity financing because lenders demand lower returns on their investments compared to equity investors who expect higher returns.
Tax Benefits: The interest paid on debt financing is tax-deductible, which means that companies can reduce their taxable income by deducting the interest paid on their debt.
Maintaining Ownership: Debt financing does not dilute the ownership of existing shareholders or investors, which means that the company can maintain its ownership structure.
Creditworthiness: By taking on debt and making regular payments, companies can improve their creditworthiness and gain access to additional sources of capital in the future.
Cons
Financial Risk: Debt financing involves taking on financial risk, as companies have to pay back the borrowed amount with interest even if their revenue declines or their profits decrease.
Limited Funding: Debt financing is limited by the amount of borrowing capacity that a company has, which means that companies may not be able to raise enough capital to finance their growth or expansion plans.
Covenants and Restrictions: Lenders may impose covenants and restrictions on companies that take on debt, which can limit their financial flexibility and restrict their ability to make certain business decisions.
Loss of Control: In some cases, lenders may require collateral or a personal guarantee from the company's owners, which can result in a loss of control over the company's assets or decision-making.
Direct Comparison
When it comes to directly comparing debt and equity financing the true defining line should be the cost of capital and how much you are willing to pay. With debt financing, you retain hold over your company and avoid diluting your shares and instead take on a mitigated risk. The biggest challenge when utilizing debt financing is using it responsibly. If you only take out a loan for how much you can afford and make smart financial decisions then debt financing can be a massive boon for your business with no risks.
When using equity financing, it can be a common misconception that you do not have to pay the loan back, this is due to the nature of the transaction and that you have given a percentage of your equity away in exchange for this. However, you continue to pay overtime by sharing profits and control and this could continue indefinitely, costing you more in the long run of your business.
When making your decision of which path to proceed down, ensure that you are fully considering how much you want to pay over time as well as if you are ready to give up a percentage of the business that you worked so hard to start. If your business is struggling to qualify for debt business financing or you are a start-up in the early stages of your business then maybe equity financing is the best option for you, but if your business is doing well and you can qualify for debt financing then taking out a business loan may be the best course of action for you and your enterprise in the long run.
Keeping Your Equity With Backd
Backd specializes in providing debt financing to business owners with flexible terms and competitive rates so that they can grow their businesses the way they want to.
With working capital advances of $25K up to $2M and terms ranging up to 16 months or business lines of credit ranging from $50K to $750K and terms of 6 or 12 months, Backd is positioned to help you expand your business without relinquishing control.
Don’t sacrifice your equity to get the financing that you need. Apply with Backd today!
