You may need equity financing if you want to raise capital for your business. However, some companies use a combination of both equity and debt financing.
Both financing options have their own pros and cons. While the former involves no obligation for increased working capital, the latter does not require giving up a share of your ownership.
Under equity financing, investors buy shares in the company to make money in the form of a dividend in exchange for working capital. Unlike debt financing, it costs you a share in the ownership and profits of the company.
It is absolutely up to you which kind of funding you want to choose: equity financing or debt financing. It depends on the easy accessibility. This blog discusses in detail both types of financing with their benefits and downsides.
This kind of financing involves selling a portion of your company’s equity in exchange for the money you need to grow your business. For instance, your business needs to raise capital, so you decide equity financing will be the best option.
This is specifically considered the best option when you raise a lot of capital to hit the ground running. You will have to sell a portion of your stake, for instance, 10%. Now the investor owns 10% of the company, and hence they have the right to the decision-making.
What are the Advantages and Disadvantages of Equity Financing?
Here are the benefits and drawbacks of equity financing:
1. No debt obligation
One of the greatest benefits of this kind of financing is that you are free from all debt obligations. You can easily focus on your growth plan without planning for repayments.
2. More Capital
Another benefit is that you can raise a larger amount of money. This kind of financing is a better option than debt financing when you need a lot of money. Some private lenders may not be able to lend you this much money despite putting down collateral.
3. Access to business experience and skills
Since you are raising money from an investor, you have an opportunity to use their business experience and skills. Your investors can contribute to your business using their knowledge and contacts. In other words, it can help drive business growth.
Although there are a lot of benefits, equity financing also has some downsides.
4. Time-consuming and demanding
It is a time-consuming process. It can take a lot of time. Also it is extremely demanding. It may not be ideal if you need money as soon as possible. Further, an investor will carefully examine your business situation before deciding if it is worth investing money in it.
5. You will lose a certain portion of your hold
It is great that you can raise a lot of money from a private lender, but you will be sharing a certain portion of your capital, giving them the right to participate in the decision-making process. It is not a good idea to raise money with this approach if you do not want to lose a share in your capital.
This is the best option for those who do not want to lose a share in the capital. It involves borrowing money and paying it back over time with interest.
Debt financing is generally a suitable option when you do not need a large amount of money to keep the ball rolling.
For instance, if you get a personal loan in Ireland, you will be paying off the debt in fixed monthly instalments over time. However, you will have to ensure that your business will be successful in the coming years, so you do not face any complications in paying off the debt.
If you are a start-up, you may choose between equity financing and debt financing, but you must carefully ensure your needs. It can be very tough to get funds from an investor. In fact, direct lenders will ask you to submit your business plan for the next two years.
Investors will make a thorough research to see the potential of your business in coming years, which can be quite difficult to prove. Further, if you need small funding to fill the gap in working capital, debt financing is, of course, a better solution. For instance, you can take out short term loans in Ireland.
What are the Upsides and Downsides of Debt Financing?
Here are the benefits and downsides of debt financing:
1. Full control of your business
The greatest benefit of debt financing is that you do not have to lose control over your business. You do not need anyone else’s consent to make a decision. You will have full freedom to run it.
2. Tax benefits
Borrowing money will let you claim tax benefits that are not possible at all with equity financing. Once you pay the entire loan back, the interest you pay is tax deductible.
However, there are certain drawbacks as well.
3. Fixed expenditure
Unlike equity financing, debt financing involves an obligation. It is possible that the company faces hard times or your company struggles to produce sufficient profits due to economic crisis or any other reasons. You will have to pay off the debt. You cannot escape your obligation, no matter what.
4. Cash flow fluctuation
Although you have borrowed money to fund working capital, you have to pay back interest on top of the loan. Every month an instalment will go toward both the principal and the interest. This will certainly affect your cash flow. Make sure that you do not face a shortfall of cash to meet your business expenses after paying down instalments.
When should you use Equity Financing and Debt Financing?
Although you can consider both financing options, they are not suitable for every business. The following points tell you when it makes sense to use equity financing and debt financing:
Equity financing is an ideal option when:
- You are a start-up company, and you do not have collateral to put down.
- You are an established company and need a lot of money to run your business.
- Also you want to expand your current business.
- You are looking to sell your business.
Debt financing is an ideal option when:
- You do not need a large amount of money, and your purpose is to fund fixed and variable costs.
- You are going to launch a business, and your savings are not enough.
- Also you are an established business, and you know you will not face any cash flow complications.
- You are organized to make regular payments.
Equity financing and debt financing are both available options, but which one suits your business depends on your financial circumstances, needs and future business performance. Evaluate all these factors to ensure that you choose the right financing type