Debt vs. Equity: Determining Which Is the Best Business Financing Route

By Provident Commercial Capital July 21, 2015 No Comments

Finding the right source of business financing for your organization is one of the most important decisions you can make. With so many options, it’s crucial to take some time to consider the pros and cons of each option, and what will make the most sense overall. Here is some information that will help you in your decision on taking on debt versus bringing in equity investors.

In choosing either debt or equity, you are essentially deciding whether to borrow money from a lender (or lenders), or sell a portion of your company to an investor/multiple investors. In the debt option, you will go to a prospective lender, whether it’s a bank, friend, relative, a crowdfunding source, etc., and map out terms for a loan. In this sort of financing, you will hold onto the ownership of your business. If you have good credit, you will be more attractive to potential lenders, and possible qualify for a better loan. If you choose to go this route, your relationship with the lender will be limited (regarding the loan), and this will terminate once the loan terms have been fulfilled.

Choosing to sell equity in your company for business financing is a very different scenario. If you decide to take on equity investors, you are selling a part of your company to them. You will have an easier time getting investors interested if you have an attractive business proposal, and if the sales potential looks good. Your agreement with the shareholders will result in different levels of involvement in the day-to-day business operations. Some investors may want to be more active in the organizations’ running, others may prefer to stay hands off. Your relationship with the investor/shareholder will last as long as they retain interest in the company, i.e. one of you sells the rights of ownership.

Something to consider when making a choice between debt or equity is that, if you take on debt and the company becomes successful, the lender has no direct claim on the profits. The owners will receive a larger portion of the profits than they would if they had sold equity. The business owner does not have to keep people informed of the state of the finances, ask for agreement when making vital decisions, etc. However, in contrast to equity, taking on debt for business financing requires repayment at some point. Also, a business is restricted in terms of the amount of debt it can carry. Companies that have a large amount of debt compared to equity commonly find growth difficult due to the high cost of making debt repayments. You don’t have to choose one of the other, you can finance the business using a combination of each. However, in order to do what’s best for your business, it’s important to make your decision carefully.

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