Debt vs Equity: Making the Right Choice for Your Business

Most small businesses seeking to raise extra capital will be look to weigh up the question of debt vs. equity. Is it better to borrow money in the form of a loan, or seek investors who will provide ready cash in exchange for a slice of your business? As always, there are pros and cons to both options so it’s important to consider all the angles before making the right decision for your own business.

Debt Financing: The Pros

The main advantage of debt financing through a loan from a bank or other business finance lender is that you don’t have to give up a share of your business, meaning you remain 100% in control. Taking out a loan is strictly a money arrangement and your lender will have no say in how you run your business – provided you make your payments on time! Once you’ve cleared off your debt, you have no more ties to the lender – this is very different to the extended business relationship you have with an investor.

In addition, choosing a fixed rate and knowing the term of repayment will allow you to budget accurately – and you can write off all your interest as a tax deduction!

The Cons

The main problem with relying on debt is, of course, if you have problems paying it back. Cash flow can be a serious problem for small businesses with big loans – and being saddled with debt will make you less attractive to investors, should you seek equity financing later.

With a loan, you’ll need to make your repayments on time whether business is good or bad – and you may have to personally guarantee any borrowing. If sales nosedive, that could leave you personally liable for all your business debts. Be sure you don’t borrow more than you can realistically afford.

Equity Financing: The Pros

If you think you might struggle to repay a large business loan, equity financing can provide your business with a relatively risk-free cash injection, as there’s no requirement to repay the money back. Without having to make burdensome loan repayments, you’ll have more cash available to grow your business and most investors won’t seek returns too soon.

The Cons

However, opting for equity financing means giving up at least some control of your business, and some investors may want a major say in the running of your operation. While you share risks, you also share rewards – so if your business is a success, you’re likely to pay out far more in profits than you would making a loan repayment.

If you’re used to being your own boss, you might not enjoy having to consult with your investors on business decisions, both big and small, and in the worst case, your equity partners may even seek to wrestle control of the business from you.

Be sure to come to an arrangement with the investor that you are comfortable with, don’t give up more of your business than you would like to just for the cash!

In borrowing, there’s no such thing as free money with no strings attached, so opting for a combination of debt and equity financing may provide the right balance for your company.

Featured image used under creative commons license

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