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Equity Vs Debt Financing: Which Way to Go?

In order to expand a business finance is mandatory but raising finance for the business depends on entrepreneur. There are two ways to raise funds for business. Let's find out what suits you best.
BY Akshay Arora
Feature Writer, BusinessEx
Dec 04,2017

A business needs funds to expand its operations, to pay off daily expenses, and to carry out necessary activities but in order to raise the funding, it is necessary to select the mode of it. There are two ways to raise funding for business which is either by equity financing or debt financing. Now the difficult part is deciding the best option. Before coming to deciding part lets first understand the basics of both the approaches.

What is Debt Financing?

Debt financing is nothing but securing funds from lenders. This could be done either by taking loans from banks or by financial institutions. There is no dilution of stakes involved in this process but a certain percentage of interest is charged by the lenders which the borrower needs to pay before the due date. Generally, entrepreneurs fear taking loans from lenders because it is mandatory to return the amount regardless they dont have the sufficient funds to repay.

Advantages:

  • You can calculate the risk by calculating the amount that you need to pay after a certain period.
  • You can easily pitch for funding from any bank or financial institutions.
  • You dont have to dilute ownership in exchange for the funds your business raised.
  • The relationship is temporary between both the parties and ends when the due money is paid by the borrower.
  • The interest amount that the business needs to pay is tax deductible.

Disadvantages:

  • If a business takes too much debt then it becomes difficult to pay back the interest and the amount due.
  • If the debt of a business is high then investors may put the business in the high-risk category through which equity financing option for a business will be closed.
  • Sometimes a lender asks for security (collateral assets) in exchange for a loan. The borrowers get hands on the assets when the due amount and interest is paid. Suppose, if a business is unable to pay back, the bank sells the assets to regain the funds invested.
  • The lenders check the credit score and business financial before financing which makes it difficult to raise funds.

What is Equity Financing?

Equity financing is securing funds through investors. Every entrepreneur plans to raise capital through investment but forgets the difficult part which is to convince them to do so. In this type of financing there is no interest charged by the investor but sometimes investors acquire stakes from the firm or take a small cut from the profit elevated by the business. The best part of this approach is you dont have to plan that you have to raise this much fund by a particular period of times as it is not necessary to return the amount.

Advantages:

  • There is no need to return the amount raised and no interest is charged as well.
  • This relationship lasts longer and helps a business to build good connections in the industry.
  • A business will have more cash on hand to expand their business.
  • Despite you fail investors wont ask to repay the amount invested.

Disadvantages:

  • The biggest challenge is finding the potential investor.
  • The investors get some control over your business as you have to dilute some shares for your business in order to raise investment.
  • You need to make big decisions for by consulting the views of investors.
  • Sometimes it costs more amount than you actually secured through investment.

How to decide the best option for business?

Well, you must have a clear view about both the approaches but now deciding is the essential part. Only you can decide this by asking yourself these basic questions:

  • Do you want to dilute the ownership of your business or pay interest on a timely basis?
  • Do you need cash flow on hand or keep control on spending by keeping in view of repayment of the loan?
  • Do you have the good credit rating to qualify for debt financing?
  • Are you ready to pitch your business idea to an investor?

These are the basic questions that you need to decide to select a financing approach for your business. If you have a problem with finding good investors then leave that to BusinessEx platform. You can easily register and find a number of investors waiting for a good business opportunity like yours.

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