Debt Financing vs. Equity Financing: How Should You Finance Your Business?

by | Last Updated: Apr 17, 2022 | Business Strategies | 0 comments

More than ninety percent of businesses do not have an account balance as strong and attractive as Apple or Google.

This means that a lot of businesses have to look for sources to finance their business from time to time in order to access capital and raise money according to their needs. There are even several large companies that may routinely seek funds for capital infusions so that they can meet with their short-term obligations.

As for small businesses, it is more necessary for them to look for such sources. However, finding the appropriate funding model according to the need and status of the company is vitally important. This is because if you take on a loan from a wrong source there is a high chance that you will lose:

  • Part(s) of your company
  • Control over your finances
  • Sleep over unmanageable debts

You will invariably find yourself and your business locked into the strict and demanding repayment terms of the creditors that will certainly impair the growth of your business not only for the short period but also for many years to come in the future.

Therefore, here are a few basics of business financing that you should consider when you are looking for a suitable source and an apt loan to finance your business needs.

About Debt Financing

You may already know a lot about debt financing as this is the most common form of financing any business. Debt financing for your business is, in fact, something you that you understand even better than you think.

Typically, debt financing for your business works just like a mortgage or automobile loan. It comes from a bank or any other lending institution. It is also likely to be provided by private investors and even online resources such as, although it is not the norm. This is how it works:

When you decide to take a loan for your business, you approach the bank and complete the loan application.

  • If your business is just at the early stages of development, the bank will check your personal credit score otherwise go through the business records and credit.
  • If your business has a more complex corporate structure or has been in existence for a considerable period of time, the banks will also look into other sources such as the Dun and Bradstreet file, which is by far the best-known source for businesses’ credit histories.

Once the due diligence is completed, the bank will approve your loan and then set up the repayment terms along with the interest rate to be charged.

The Pros and Cons of Debt Financing

There are several advantages that you can enjoy when you finance your business through debt. These include:

  • Getting the money but not having to forego any control or ownership of your business to the lender
  • Running your company as you wish even when you are in a relationship with the lender so long as you make the payments on time till the term ends
  • The amount of interest you pay on the debt financing is usually tax-deductible since it is an expense of your business
  • Forecasting your monthly payments well as these are your business expenses.

However, debt financing for your business will also come with some specific disadvantages which are good to know before you make your final decision.

Debt payment added to the monthly expenses of your business will mean that you have to have the capital inflow to meet with all your business expenses including the monthly bills for your debt. However, when it comes to small businesses or those at the early stage, guaranteed cash flow is rare.

Another significant disadvantage of debt financing a business is that it’s extremely difficult to get any sort of small business loan during recessions. During these times, until and unless your business is overwhelmingly qualified for a loan, it will be very difficult for you to get debt financing.

About Equity Financing

If you do not have any idea about equity financing and how it works, you should go watch the ABC’s hit series “Shark Tank.” These are the funds that typically comes from the investors often called by different names such as Anel investors and Venture Capitalists.

A venture capitalist is usually a firm instead of an individual, as you may presume. This firm has several partners, investment advisors, teams of lawyers, and accountants. All of them perform their share of due diligence on any potential investments that the firm wants to make. The investments made are quite large, often amounting to $3 million or more. This makes the process slow, apart from the fact that deals are very complex in most cases.

Angel investors, on the other hand, are usually referred to those wealthy individuals who have a lot of money and look for businesses to invest in rather than build a business of their own. They invest smaller amounts but are the perfect option for businesses that are looking for cash to develop their product or project. Though it is hard to find these angels, they really will move fast and invest in much simpler terms once you can convince them about your business prospects and returns.

The Pros and Cons of Equity Financing

One of the biggest advantages of equity financing is that you need not pay back the money. Since they are part-owners of your company, they profit when the company profits. When the company suffers, they make less money.

However, the disadvantage of equity financing is that you will have to give up a part of your business ownership to them and be mentally prepared to work with a new partner. Sometimes this is not easy but when push comes to shove, this can be a suitable option to try.

Final Thoughts

There are pros and cons to each option when it comes to financing your business. Weigh them carefully before making any major decisions. 


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