Debt vs. Equity Financing: Advantages & Disadvantages
When your business needs capital to fund more of what it’s doing well, you may find yourself weighing the advantages and disadvantages of debt financing vs. equity financing.
Should your business borrow money to fund operations and growth, or should your business seek outside investors? The answer to this question depends largely upon the condition of your business and your personal preferences. Do you already have debt on the books? Is your cash flow predictable? How comfortable are you with partners?
Debt financing means borrowing money. You won’t have to give up control of your company, but too much debt can weigh your company down.
Advantages of Debt Financing
Perhaps the best thing about debt financing is that it’s temporary. Your relationship with the lender is mostly transactional. Your obligation ends when the debt is repaid. Your lender may ask for financial statements and information; however, he or she has virtually no control over how you spend your time or conduct your business.
Furthermore, debt financing is predictable. Principal and interest payments are agreed upon in advance, and servicing this type of financing can become a regular part of your company’s cash flow processes. Debt financing offers some flexibility, too. Loans can be short term, long term — or somewhere in between.
Disadvantages of Debt Financing
Sometimes it can be difficult for a business or an owner to qualify for a loan. Often, lenders will demand assets of the company be held as collateral, and owners might be asked to guarantee loans, personally.
In addition, too much debt can cripple a business.
Unlike equity financing, debt financing takes money out of your business as cash flow. If your business takes on debt — and if cash flow becomes unpredictable — you or your business might have a hard time making payments. Finally, if you ever want to take on investors in the future, they’ll likely regard your business as riskier if it has too much debt.
Advantages of Equity Financing
Equity financing is often the less risky choice, because — as strange as it seems — you’re really under no obligation to pay the money back. With equity financing, you won’t have fixed, monthly loan payments, and — usually — your investors will not be seeking an immediate return.
Equity financing facilitates long term planning, especially when your investors take a long view of your company. This can benefit start-ups or companies seeking to enter new lines of business.
Disadvantages of Equity Financing
You will have partners, and your partners will expect to receive a return on their investments.
When you give up equity for cash, you agree to give up some of your profits. And, sometimes, the amount you return to investors will cost your business more than the interest rates demanded by lenders.
When you finance with equity, you also give up some control of your company.
Equity investors typically want a voice in business decisions, and if you’ve taken on many investors, you may not be able to satisfy everyone. Before you take on partners, consider whether you’re able to manage and resolve potential conflicts and disagreements.
Something Else to Consider
It’s worth noting that with the right investors, participation in business decisions can be a good thing. Sometimes, investors have industry contacts, experience, or insight that can make growing your business easier.
So if you choose equity financing, try to find investors who understand your business or industry. Some might be well-connected, allowing your business to potentially benefit from their knowledge and their business network.
Are you in the sportfishing or landscaping products business? So are we. If you want to learn more about how we help companies grow, we encourage you to contact us.
Elvisridge Capital seeks established, privately held, middle- to late-stage businesses based in the United States. We invest in situations where our experience and resources can help generate significant profitability improvement and revenue growth. To begin a conversation, contact us at info@elvisridgecapital.com.
