When Should You Raise Debt vs Equity?

It’s a simple fact, you will need extra funds to grow your business. So, should you look for an investor or apply for a business loan? Debt and equity have their own share of pros and cons. Debt financing involves borrowing money from a lender and repaying it with interest at a later date. It’s available in various forms such as credit and business loans. The latter usually has strict requirements for approval.

Those who were not able to meet these requirements can turn to alternatives such as business credit cards and merchant cash advances. These alternatives often allow borrowers to make weekly payments instead of fixed monthly payments.

One of the best things about debt financing is that you retain full control of your operations. The terms are also finite and payments for your debt are usually tax-deductible. The interest rate, however, can be quite high. The total amount repaid might even be higher than the initial sum.

You also need to make payments regardless of your income’s stability. This can be dangerous for startups and small businesses. Borrowers usually need to start repaying the loan after one month, which can be challenging for them as their finances are not yet stable. The lender could also seize your assets if you fail to reimburse the loan.
Equity financing, on the other hand, involves selling a share in your company to venture capitalists or angel investors in exchange for their investment. Since you don’t need to pay interest, you don’t have to put your profits into repaying debts. You will get more funds to grow your business. Equity financing is great for tech companies and other businesses in high growth sectors. You also don’t need to make repayments when you are not making profit. Aside from this, you can gain wisdom, experience and industry connections from your investors.

To convince venture capitalists or angel investors to put money into your business, you need to have a competent management team, pro forma financial statements and a working service or product. However, you shouldn’t sell more than 49% of your business because you will lose the majority stake in your company. You will have less control over the company operations and even lose the management position if the shareholders want to change leadership.

Which Option is Right for You?
Consider the following points when deciding between debt and equity:

• You should consider how much capital you need. If you only need a small amount of cash, then you should go for debt financing. Investors often invest large amounts of cash in businesses that they believe in. If you think you could use more funds, then either equity or debt could work for you.

• Consider how soon you might need the additional funds. Debt financing is ideal for those who need cash fast. You can apply for a business loan and get approved within a few hours. Equity financing, on the other hand, takes time as it involves looking for the right investors, promoting your business and preparing all the legal documents.

• If you’re fine with sharing your business, then you should consider equity financing. Debt financing is ideal for those who don’t want to lose control over their business. If you are more concerned with additional capital than ownership or you want to benefit from the expertise and experience of an investor, then either option could work for you.

• Equity allows you to access an investor’s expertise and contacts. Debt financing doesn’t offer this particular advantage. With equity financing, you get to build relationships that could have a positive impact on your business. If you just want additional cash, however, then it’s best that you go for debt financing.

• If you want to enter the global market, then equity is a great option for you. Venture capitalists and angel investors are often looking for businesses with the potential to grow into international brands. If you prefer to stay small because you like the autonomy and individuality of your business, then equity may not work for you.

The right type of financing will have a deep impact on your business. It’s always best to study the pros and downsides of each option and understand which one is best for the current stage of your business. Study several financial products to know what fits your needs. You can also consider combining equity and debt financing to meet your needs.
Regardless of which one you choose, it is imperative that you have a reliable corporate lawyer who can help you understand your financing options and represent you properly. This is particularly important if you want to sell shares in your company. You must make sure that everything is legal and that you still retain control over your business.