Debt vs. Equity Financing: Which Represents the Better Option for Small Businesses?

Debt vs. Equity Financing: Which Represents the Better Option for Small Businesses?
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Capital is necessary for small businesses especially in the early stages of growth. It can be difficult to find a source of capital. Tighter lending criteria and venture capitalists still struggling with the recessionary fallout create an atmosphere where funding is a problem. There are several sites to get information about financing. A good one isreviewsbird.co.uk. You will find various reviews about wealth management companies on the site.

Small companies have two common types of funding available – debt financing and equity financing. What is a better option for you as a small business owner?

Debt financing

Common forms of debt financing include buying assets like a home or a vehicle using a credit card. You are obtaining a loan from an individual or corporation and making a contract with interest to pay it back. Debt funding for the business operates in a similar manner. You may apply for a commercial loan from a bank as a business owner, or accept a personal loan from relatives, family or other lenders, all of which you have to repay. To escape the gift tax, even family members that lend you money for your company must charge the minimum IRS interest rate.

The benefits of financing debt are extensive. First, there is no control over your company from the lender. Your arrangement with the financier stops once you repay the loan. Second, the interest you incur is deductible from tax. Finally, since debt payments don’t fluctuate, it is easier to predict expenditures.

For someone who has debt, the risk of debt financing is very significant. Debt is a gamble on your willingness to pay back the debt in the future. What if the business hits hard times or the economy suffers a meltdown? What if the company does not expand as well as you anticipated? Debt is an expense, and you have to pay expenses regularly. This could take a toll on the potential of your business to expand.

Equity financing

Since equity financing involves investors, the public does not grasp equity financing like they do debt financing. You could sell shares of your business to families, friends and other small investors, but equity funding also involves angel investors or venture capitalists.

The major benefit of equity investment is that much of the risk is taken by the investor. You do not have to give the money back if the business crashes. Also, since there are no interest fees, you can have more cash available. Lastly, investors take a long-term perspective and appreciate that it takes time to develop a business.

The disadvantage is significant. To obtain the funding, you would have to give the investor a portion of the business. Any time you make decisions involving the business, you will have to distribute your profits and collaborate with your new partners. Buying them out is the best way to remove investors, but it would actually be more expensive than the funds they initially offered you.

Which is the better funding method?

Particularly for small, early-stage businesses, formal equity capital is hard to secure. Venture capitalists are searching for globally-reaching businesses. So, if your business is a start-up that targets a small market and does not require large-scale capital, debt financing is potentially your best choice.