Start-up capital is hard to come by. Even with your savings, you will soon realize that you need a capital raise and this is when you will have to choose between the two common financing methods:debt financing and equity financing. .
SummaryWhat are these two financing options?Amount neededEmergencyOther needs besides moneySharing your businessInterest and feesEssentially what these two options ask is whether you (1) need to take out a loan for the capital or (2) get an investor ready to invest in your business. Either option has significant business consequences, hence the in-depth considerations.
Under debt financing , you will borrow money from a lender with interest and you will have to repay the money after an agreed term. On the other hand,equity financing This is where you exchange ownership of your business for investment funds. Equity investors often include venture capitalists and angel investors.
Due to the disparity associated with these business financing options, you cannot blindly obtain funds from either source.
Before signing an agreement, keep the following factors in mind:
How much capital does your business need? The amount of capital required by your business will always determine the means of raising the money. It doesn't make sense to seek out a venture capitalist when your business only needs a small financial injection. Therefore, when you need a small amount of capital, debt financing is the best alternative.
Venture capitalists and other investors make big investments and it is a financially sound decision to seek them out when they need a large sum of money.
Loans are viable financing solutions in times of urgent need for funds. Although there are associated costs, the urgency of the need overrides the associated transaction costs, which makes debt financing a great approach. Some of the readily available and affordable debt financing options include SBA loans or online borrowing from peer-to-peer lenders.
Meanwhile, all forms of equity financing take time. You need to find investors, pitch your business to investors, prepare financial projections, draft legal documents, and convince investors to invest in your business. Equity financing is therefore the best alternative when looking for funds to use to further develop the business.
Are you looking for something other than a financial boost? Do you have big expansion plans? Do you anticipate rapid business growth and need a significant boost? You need equity financing.
Equity lenders often look at a company's growth potential and how they can get better returns for their investments. If you foresee this and are looking for financing to get there, then you need to start your search for equity lenders. You will need to prepare a comprehensive business plan, detailed financial projections and business history reports. These are essential for venture capitalists or angel investors, but unnecessary in debt financing.
For equity financing, you also need to have a strong management team, strong marketing acumen, and a passion for your business. These will help convince investors and will also take a lot of time.
Although venture capitalists hold a stake in your business, they will provide your business with excellent and professional advice and guidance, which will save you from unnecessary pitfalls and mistakes. Equity investors are very experienced and they will be the best mentors for your business.
Just like many other millennials who run start-up businesses, you may end up with student loans and other debt. Along with helping you with the business, stock lenders will guide you on how to control the many debts. The most effective and commonly advocated debt management strategy is debt consolidation.
The debt consolidation option helps control repayments by reducing the number of loans payable monthly as well as the amount payable monthly at the end of the debt repayment period. With the lower interest rate applied on the debt consolidation loan, you will be in a better position to manage your debts and expenses. Besides personal loans, debt consolidation is an effective alternative to debt financing for student loans, unpaid bills from creditors, and credit card debt.
If you are looking for a large investment from venture capitalists, you have to accept the fact that you will have to share your business with an investor. If sharing the ownership and profits of the business is not for you, debt financing will be your option. You should note that a loan may not be sufficient to provide you with the necessary financing.
When you need the expertise and advice of an equity investor alongside financing, then you should clearly highlight this fact and request repayment of the financing.
In addition to obtaining bank loans and requesting simple financing from investors, you can take advantage of platforms offering crowdfunding. You should also consider talking to friends and family, or getting loans from non-governmental institutions, microfinance organizations, or even getting affordable government loans. There are also accelerators for startups that one can benefit from.
When taking the debt financing option, you should keep in mind the interest rate charged and the associated transaction fees. The rate charged is determined by your credit score. With possible high debts from business and personal loans, as well as your student loans, you may be considered a risky borrower. In this case, your loan application could be refused or approved at a high interest rate.
While considering debt financing, look at the repayment terms. Be smart, get the amortization schedule from the lender and figure out if the loan will be expensive or affordable at the end of the repayment period.
In conclusion, your choice will depend on your personal interests, urgency of funding, cost of funding and future implications on business growth. Finding the right financing option has lasting effects on how your business operates after financing. In some cases, a business may even need both financing options to be successful.
See also:5 Ways Business Investment Loans Can Help Your Startup
