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Debt Financing vs Equity Financing: Which is Best for Small Business?

By Finserv MARKETS - Jun 3,2019
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Debt Financing vs Equity Financing

Financing a business is always a challenge for small business entrepreneurs. A business without cash flow can cripple within months of its establishment. Therefore, until the foundation of the business has not been entirely formed, capital is crucial for its sustenance. There are two types loan options available for business – debt financing and equity financing.

What is Debt Financing?

A debt financing is almost like business loan, except, it’s taken from an outsider as opposed to a financial institution. When we borrow money from a lender, the only condition they seek is the guarantee to pay back. We need to repay our loan in instalments which includes EMIs and the principal amount. In debt financing too, we need to repay the loan in a similar manner but here the loan is provided only if your business model seems promising. The person investing in your business might not take any share of profits. Nevertheless, they will want the amount to be used for a smart business idea that will convince them to invest.

Although the idea of debt financing may sound comparatively easy. It does come with its own set of setbacks too. In debt financing, the timelines set to repay the loan are extremely strict and failing to adhere to the pre-fixed timelines, can attract legal actions.

In debt financing, if your business involves acquiring a rather hefty amount of cash. Getting an investor in that scenario also becomes difficult.

If your business undergoes loss, then the debt financing will leave your business vulnerable.

A debt financing is secured only after you pledge your assets, failing to repay the loan will cost you both business and assets.

Pros and Cons of Debt Financing

Pros of Debt Financing

Cons of Debt Financing

With debt financing, you get the flexibility to use the loan amount for your business needs without any outside interference.

If you have a low credit score, it can be tough to qualify for the loan you wish to avail for your business.

Tax deduction is a major benefit of debt financing. Usually, the principal and interest payments on a business loan are considered as business expenses, and therefore, they are eligible for tax deduction.

In case, you fail to make timely repayment of the loan, the lender may seize your business’s assets that you pledged as collateral

Debt financing can be repaid through easy monthly instalments. This will reduce your cost of capital and boost the cash flow of your business.

The loan availed can impact your credit rating. Therefore, before you apply for a loan, you must check with your lender to determine if the credit check performed will affect your credit score.

What is Equity Financing?

Equity Financing is allowing a person or an entity to invest in your business and buy a share of it. Instead of repaying the loan in EMI, you let the person take a profit from your business and own a share as well. This is blessing in a way because you don’t have the burden of paying someone in regular instalments. Also, this negates the pressure of making money just to clear the loan on business. This module gives your business the chance to grow and share profits, once it starts churning profits. There are many ways to avail an equity fund, it could be a private investor, a firm, family or a friend.

The drawback of equity financing is that you are no longer the sole owner of the business. When you get into partnership, you have to respect the views and decisions of your partner as well. You cannot take the decisions independently and that may lead to clashes. Even though, it is an ideal situation for someone to take money without having to worry about the repayment. In a shared venture, you have to agree to the terms and conditions set by the investor, failing to do which could lead to the loss of partnership.

Pros and Cons Equity Financing

Pros of Equity Financing

Cons of Equity Financing

In equity financing, you are not required to pay interest on the capital raised. Therefore, you will have more cash for the growth of your business.

One of the major drawbacks of equity financing is that you would be giving away the ownership of your business. This means before making any decisions, you would be required to consult the investors.

If you find a right investor for your business, you can expand your business outreach, make new connections, gain experience and much more.

Equity financing can take a longer time as compared to debt financing.

Unfortunately, If your business fails, you won’t be required to repay the investments.

In equity financing, you would be required to share some of the company’s profit with your investors. Sometimes, the amount of money paid to investors could be higher than the interest rates on debt financing.

How do you know which is right for you?

While choosing between debt financing and equity financing, you should take certain aspects into consideration. Some of them are mentioned below:

  • If there’s an urgent requirement for a small amount of money, it is advisable to opt for debt financing.
  • If you are looking for substantial capital along with some expertise to grow your business and widen your connections, you should go ahead with equity financing. On the other hand, if you only wish to avail the required funds for expanding your business, debt financing would be a preferred option.
  • If you wish to have complete control of your business, opting for equity financing isn’t advisable. This is because in case of equity financing, you’ll be required to share your business with the investors. Therefore, before making any business decision, you would’ve to discuss the same with your investors.
  • If you aim to expand your business on a national or global scale, you can consider taking the help of angel investors by opting for equity financing. Whereas, if you prefer to run a local business and hold complete ownership of it, debt financing would be an ideal choice.

Conclusion:

We hope this summary gave you a fair idea to what investment suits your needs. The market is full of lenders willing to assist, you have to select the one that compliments your business. Equity or Debt, eventually both require you to make the most of the money borrowed and strive towards making your business a success. We at Finserv MARKETS, offer Bajaj Finserv business loan, which has many benefits like flexible repayment options, 3 minutes approval, and more, which can prove to be the best option for your business to flourish. So, why wait? Apply for business loan on Finserv MARKETS now!

 

“Finserv MARKETS, from the house of Bajaj Finserv, is an exclusive online supermarket for all your personal and financial needs. We understand that every individual is different and thus when you plan to achieve your life goals or shop for the gadget of your dreams, we believe in helping you Make it Happen in a few simple clicks. Simple and fast loan application processes, seamless, hassle-free claim-settlements, no cost EMIs, 4 hours product delivery and numerous other benefits. Loans, Insurance, Investment and an exclusive EMI store, all under one roof – anytime, anywhere!”

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Bajaj Finserv Direct Limited ("BFDL"), erstwhile Bajaj Financial Holdings Limited is a registered corporate agent of Bajaj Allianz Life Insurance Company Limited and Bajaj Allianz General Insurance Company Limited under the IRDAI composite registration number CA0551 valid till 10-Apr-2021. BFDL also renders services to Bajaj Finance Limited (‘BFL’) and Bajaj Housing Finance Limited (‘BHFL’) (referred hereinafter as ‘Lending Partner’) in sourcing of customers, providing preliminary credit support activities, fulfilment services and post-acquisition customer services related to lending business. Registered Office: Bajaj Auto Limited Complex, Mumbai – Pune Road, Akurdi, Pune – 411 035 CIN: U65923PN2014PLC150522