Determining what type of financing is right for your small business can be a challenge if you don’t fully understand the criterion that needs to bet met to qualify. There are several categories of financing that you may qualify for as a small business owner, including debt and equity financing. There are a variety of different types of debt financing you may qualify for – including small business loans and lines of credit.
Lenders across the U.S. typically have similar, standard criterion that you would need to meet to get approved, so it is easier to find a suitable lender for your small business if you’re going after debt financing. However, equity financing is a bit different. With equity financing, private or institutional investors will invest in your small business in exchange for a percentage of ownership in your company. Furthermore, investors typically have very unique interests therefore the criteria you need to meet to get an investor to invest in your small business may vary greatly from investor to investor.
The criterion for approval isn’t as similar amongst investors as it is with banks and lenders. This is why it’s important to be able to determine which one will be right for your small business before you attempt to go after financing. Determining which one is right for your small business is all based on your business plan – (i.e. your business goals and objectives). Below is a list of the pros and cons associated with debt and equity financing. This list will help you determine which one is right for your small business.
Pros – Debt Financing
- You can retain 100% ownership of the business.
- Lenders will not be able to control how you run the business since you have full ownership.
- Loan interest is tax deductible.
- Your relationship with the lender is over upon repayment of the loan.
Cons – Debt Financing
- Repayment of the loan must be done within a certain time frame.
- Relying heavily on debt and cash flow problems may cause you to default on the loan.
- A personal guarantee is usually required to get approved for debt financing (especially if your business is a startup).
- Collateral is sometimes required to be pledged to a lender to get approved for a loan.
- Carrying too much debt can limit your ability raise equity financing in the future because investors will view your business as high risk.
Pros – Equity Financing
- You most likely won’t have to pay anything back if the business doesn’t succeed.
- Most investors don’t require an immediate return on their investment, giving you ample time to build the business.
- Investors are often well connected and can help you meet the right people to help you grow the business quickly.
Cons – Equity Financing
- Investors will require a significant percentage of ownership in the company depending on the amount they invest.
- It can take a considerable amount of time to find an investor that is suitable for your business since most investors have very specific interests.
- Investors will have significant control over your company and how it operates. This means many of your ideas can be overlooked if investors do not agree.
- You could lose the business to the investors if they are not happy with the way you run things.
Debt and equity financing can be mutually beneficial because the pros and cons of each can often balance each other out. It may be wise to take advantage of both if you find that it’s suitable for your small business.