Debt vs. Equity Financing: Which Way Should Your Business Go?

debtequity

Debt & Equity

Your small business needs extra capital. Finding that money can be difficult. Tighter lending standards and venture capitalists are producing an environment in which funding is a challenge.

Should you take out a business loan or look for an investor? Figuring out how to finance your business is an important decision that can have big consequences. So which is better? Debt or equity?

Let’s quickly go over their differences, then talk about how you can make this big decision.

 

What is debt financing?

Essentially, debt financing is where you borrow money from a lender that you’ll eventually pay back, plus interest. If you’ve ever taken out a loan, you’ve financed something with debt.

Pros of debt financing

The advantages of debt financing are numerous.

  • First, the lender has no control over your business. With a business loan, you’re in control of how that extra capital gets spent. Some lenders impose certain restrictions, but for the most part, what you’re financing is up to you. Once you pay the loan back, your relationship with the financier ends.
  • A business loan won’t leave a lasting impact on how your business gets run, other than the loan payments you’ll owe.
  • Debt financing is a flexible category. There are many different kinds of business loans with wide ranges in how much money you’ll get and how long you’ll make repayments.

Cons of debt financing

  • You’re paying for the cash you get. Although, if you plan correctly, anything you borrow should help you make even more back.
  • Depending on your credit score and financials, it can be tough to qualify for the loan you want.
  • If you fail to repay the loan, your business’s assets could get seized by the lender.

 

What is equity financing?

Equity financing is where you trade ownership of your business to angel investors or venture capitalists — in return for their capital.

Equity is especially important for certain industries and kinds of businesses, like technology startups and companies with global aspirations.


In Tanzania the concept of equity is not widely known to MSMEs and the public at large.


The Dar es Salaam Stock Exchange in 2013 introduced a special segment known as Enterprise Growth Market to help MSMEs raise substantial capital to drive their growth plan while benefiting from increased profile and liquidity within a regulatory environment designed specifically to meet their needs.
Experts say that there is no worry for people and small businesses to hesitate using stock markets since it is a right place for them to generate capital for business expansion.

Pros of equity financing

  • You don’t have to pay interest on the capital you raise, so there’s no need to put your business’s profits into debt repayments. This means you’ve got more cash available to grow your business.
  • With the right investors, you can get great experience, wisdom, industry connections and much more. These relationships can last you a very long time.
  • If your business fails, you’re not required to pay back investments.

Cons of equity financing

  • It takes a long time — especially when compared to some of the fastest debt financing options out there.
  • You’re giving away ownership of your business, and with that, decision-making power. You’ll have to consult with investors, and you might disagree over the direction of your company. You might even be forced to cash out and abandon your own busines

However the downside is large. In order to gain the funding, you will have to give the investor a percentage of your company. You will have to share your profits and consult with your new partners any time you make decisions affecting the company. The only way to remove investors is to buy them out, but that will likely be more expensive than the money they originally gave you.

How do you know which is right for you?

If you’re having trouble deciding between debt and equity financing, here are five questions to ask yourself.

  1. How soon do you need financing?

 

If you need cash as soon as possible, then debt financing is the way to go. You can get business loans incredibly fast — in a matter of hours even, if you apply to the right lenders. Meanwhile, equity financing involves finding the right investors, pitching your business, drawing up the legal documents and more.

However, if you’re not in a big hurry, either option can work for you. The biggest and most affordable loan options — like a SBA loan — will probably take around as much time as equity financing.

  1. How much capital do you need?

If you don’t need a lot, or you’re only looking for a small amount, then debt financing is the better choice. Equity financing rarely comes in small amounts, but you could get business loans for as little as Sh100,000 or less.

  1. Are you looking for more than just money?

If so, equity is probably for you. Debt financing is transactional. You borrow, then you pay back what you owe. Equity will give you access to an investor’s knowledge, contacts and expertise. You get to establish a relationship that could have a hugely positive effect on your business — as long as you’ve partnered with the right people. If all you want is more cash in your bank account, then it might be best not to get involved with investors.

  1. Do you mind sharing your business?

Some entrepreneurs prefer to keep their businesses to themselves — and that’s okay. If you don’t want to lose control over how your business operates, then equity financing isn’t the way to go. If you’d welcome the experience and expertise of an investor, or if you’re more concerned with funds than ownership, then either path could work.

  1. How big do you want to get?

Angel investors and venture capitalists often look for companies with the potential to grow into national brands or global businesses. If that’s your goal, then equity can help you get there. However, plenty of entrepreneurs prefer to run a local business, staying small because they like the individuality, autonomy and community aspect. If you fit that mold, equity probably won’t be an option.

Finding the right kind of financing is a big deal, and it can have a deep and lasting effect on how your business runs. Also, don’t discount combining debt and equity financing, according to what you need at the time. Plenty of businesses make use of both.


Make a choice

The type of financing you seek depends largely on your startup. If you are just getting started, consider a loan from family, friends or a bank. As you grow and reach a larger market, equity funding may become a more viable option if you are willing to give up a portion of your company.

What Do I need to have to get debt remedy

Your first step should always be to get free expert debt advice, based on your personal circumstances. No matter what your debt problem, we’ll be able to help

To get the most out of Debt Remedy, or a call to our telephone debt helpline, it’s useful to have the following details to hand:

  • Details of all your debtsWe’ll gather details of your income, outgoings, unsecured debts and any assets you have.
  • Your incomeincluding any benefits or pensions.
  • Your household billsfor items such as food and utilities, with details of any missed payments.
  • Approximate values of assetslike your home or car.
Definition

equity is the difference between the value of the assets/interest and the cost of the liabilities of something owned

Onwer's Equity

When starting a business, the owners put funds into the business to finance various business operations. Under the model of a private limited company, the business and its owners are separate entities, so the business is considered to owe these funds to its owners as a liability in the form of share capital.

Throughout the business’s existence, the value (equity) of the business will be the difference between its assets (the value it provides) and its liabilities (the costs, such as the initial investments, which its owners and other creditors put into it); this is the accounting equation.

Equity Investment

An equity investment generally refers to the buying and holding of shares of stock on a stock market by individuals and firms in anticipation of income from dividends and capital gains, as the value of the stock rises. Typically equity holders receive voting rights, meaning that they can vote on candidates for the board of directors (shown on a diversification of the fund(s) and to obtain the skill of the professional fund managers in charge of the fund(s).

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Frequent Asked Questions

Why Do I need to Debt Consultant

Your first step should always be to get free expert debt advice, based on your personal circumstances. No matter what your debt problem, we’ll be able to help.

What is the Debt - to - Equity Ratio

Debt to Equity ratio is a financial ratio indicating the relative proportion of shareholders’ equity and debt used to finance a company’s assets. Closely related to leveraging, the ratio is also known as Risk, Gearing or Leverage.

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