There are many ways to grow a business, and almost all of them require you to spend money.
Raising capital as a business owner is a balancing act. While there are several ways you can raise the money you need, debt and equity financing are the two most common options.
Taking on debt isn’t something you should be afraid of as a business owner. Debt is simply another tool you can use to purchase assets, secure suppliers, hire talent and reach your goals.
In this article, we’ll explore the advantages of debt financing for your business, as well as how it compares to equity financing.
What is Debt Financing?
Debt financing occurs when a business borrows money from a third party lender. In return, you agree to pay the money back with interest.
Debt financing is available from banks and other major financial institutions. You may also be able to access debt financing through your suppliers, e.g. financing the purchase of company equipment.
This type of financing is a simple and effective way to raise capital and fund your business activities. The risk is relatively low, although directors may sometimes be required to provide personal guarantees to secure financing.
What is Equity Financing?
Equity financing occurs when you sell a share of your business to an investor. The funds raised through the sale of the company share can then be used to fund business activities.
The investor effectively becomes a part owner of your company. They share in the profits and losses of the business, and they may want a say in business decisions.
The Advantages of Debt Financing for Your Business
Debt financing is an accessible and flexible option that’s ideal for companies of every size. This tactic comes with several distinct advantages:
- Retain control and ownership. Equity financing requires you to share company control and profits with investors. With debt financing, you retain full ownership and control of the company.
- Tax advantages. Debt financing is considered a business expense. This means that fees, charges and interest payments are tax deductible.
- Predictable repayments. Repayments made against your loan are predictable, allowing you to plan and budget more effectively.
- Flexible credit terms. Debt financing is a flexible option. Lenders provide a variety of loan terms and interest rates, and loans are available to suit businesses of all sizes.
Debt financing is a relatively low risk prospect for lenders. Because they are legally entitled to repayment, lenders can provide credit at relatively low rates. If your company is profitable, debt financing may be significantly more affordable compared to sharing profits with investors.
The trade off is that you may be required to provide company assets as collateral. These assets may be at risk if you are struggling to make repayments. Additionally, loan repayments can impact your available cash flow, which may limit your ability to expand the business or manage unexpected expenses.
The Advantages of Equity Financing
Equity financing is an effective way to grow your company. While this type of financing is typically considered higher risk, it comes with a few major advantages:
- No repayments. Investors provide equity in exchange for a share of company profits. There are no repayments required on the amount of money the business raises. This can improve day-to-day cash flow and reduce the financial burden of raising capital.
- Reduced debt-to-equity ratio. Your debt-to-equity ratio compares the amount of debt your company holds compared to the value of its assets. A lower debt-to-equity ratio indicates fewer liabilities. Lower ratios can help you obtain debt financing when you are ready to grow the business.
- Support from investors. Business investors often bring useful skills and insights to the role. Investment from the right people and institutions can be an excellent way to grow your business and take advantage of new opportunities.
The major downside to equity financing is that you are typically required to give up a portion of the business in exchange for the investment. The investor then has a say in all business decisions going forward, and they are entitled to a portion of the profits.
The process of equity financing can also be complex. Selling shares (especially if your company trades publicly) is subject to strict requirements and can be a drawn-out process. For companies that need to raise money fast, debt financing may be the better option.
Choosing Between Debt Financing vs Equity Financing
Debt and equity financing are both viable options for your company. The choice between the two depends on things like your debt-to-equity ratio, cash flow requirements, ownership, ability to service repayments, and the business’ needs.
Most companies use a combination of debt and equity financing. Balancing the two helps to optimise cash flow while controlling risk and ensuring you still retain control over the business.
Get On Top of Company Debts with Support from Business Savers!
Taking on debt is an excellent way to grow your business, but it also comes with risks. If you are struggling to manage company debts, or if you are concerned about your financial position, the best thing you can do is act quickly.
The team at Business Savers are registered Liquidators and insolvency experts. We support businesses with business turnaround, administration and liquidation solutions.
We take a tailored approach to our work that helps us reach the best possible outcomes for everybody involved. We’ll work with you to assess your situation and develop a plan for managing debts, repaying creditors and restructuring your company.
Speak to us today to find out more, or book a confidential consultation if you’d like to discuss debt solutions for your business.