# A Beginner’s Guide to Debt Financing and Equity Financing for Small Businesses
As a small business owner, raising extra capital is inevitable. Whether you’re planning an expansion or covering day-to-day costs during a time of recession, there are many financing options available to you. In this article, we’ll discuss the two main types of funding options available: debt financing and equity financing.
## The Basics of Debt Financing and Equity Financing
There are two primary types of financing available to small businesses: debt financing and equity financing. While they both provide an influx of capital to your business, they are also very different from each other.
### What is Debt Financing and How Does it Work?
Debt financing is when a business borrows a fixed amount of money from a lender with an agreement to pay back the principal sum, with interest, in a specified amount of time. Small business bank loans, credit cards, and credit lines are the most common types of debt financing. However, money can come from a variety of sources. In addition to banks and credit unions, debt financing can also come from non-profit groups and even friends and family. Sometimes a lender will require collateral to secure the business loan. This could include anything of value including business assets such as accounts receivables, buildings, vehicles, or inventory.
**Advantages of Debt Financing**
– You have no obligations once you have repaid your debt.
– You are not selling a stake in your company, so there is no change to the business ownership.
– Any interest you pay on the loan is tax-deductible.
– There are a variety of lending options to choose from.
**Disadvantages of Debt Financing**
– Debt financing may require collateral to secure a loan.
– Terms will require that you pay back a specified amount of money no matter how well your company is doing.
– Serious cash flow issues, defaulting on loan payments, and risking the loss of any assets you provided as collateral for the loan.
– Lenders may impose restrictions that dictate how the money you borrow is used.
### What is Equity Financing and How Does it Work?
Equity financing is funding that comes from small business investors that buy equity investment into your company, typically in return for a percentage of profits. Small business investors can be private equity firms or, just as with debt financing, they can also be friends and family. Sometimes, but not always, a small business investor may be granted some amount of control in the business. This will depend on the terms of the deal. Most small business investors will structure a profit-sharing arrangement that anticipates seeing a predictable return on their investment.
**Advantages of Equity Financing**
– Small business investors will not charge you interest on their investment into your company.
– You’ll have more money available to invest back into the success of your business.
– Equity investors often provide a great degree of experience and business leadership.
– Small business investors only see a return on their investment if your business is a success.
– Small business investors have a much greater incentive to ensure that your business succeeds and can often provide expert guidance to help your business thrive.
**Disadvantages of Equity Financing**
– Handing over decision-making power to a third party may not be for every business owner.
– You will typically create an agreement to share a certain percentage of your profits with small business investors that you have partnered with.
## Making an Informed Decision for Your Small Business
Choosing between debt financing and equity financing will depend on your business needs and goals. Consider the following factors before making a decision:
1. Debt financing may be the better option if:
– You have a clear plan on how you will repay the loan.
– You don’t want to give up ownership or control of your business.
– You need a quick solution and don’t have time for a lengthy investment process.
2. Equity financing may be the better option if:
– You don’t want to add additional debt to your business.
– You need access to more capital or financial expertise than a lender can provide.
– You’re willing to give up some ownership or control of your business.
In the end, the most important part of any business decision about raising capital is having a solid plan on how you will effectively leverage it.
## Getting Assistance from Business Bookkeeping Services
As a small business owner, it’s important to keep track of all your finances. Hiring a professional accountant or business bookkeeping service can help you stay organized and make informed decisions about your finances.
## Conclusion
Raising extra capital is an essential part of running a small business. By committing the basics of debt and equity financing to knowledge, and carefully weighing the various pros and cons with your business needs and goals, you’ll be better equipped to make an informed decision. Remember to consider all of your options, create a solid financial plan for your business, and seek assistance from professionals when necessary.
