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Debt Financing vs. Equity Financing: Pros and Cons for Small Business
| StreetShares Blog

Equity vs. Debt Financing: Which is Right for My Small Business?

Growth. It is what small businesses must do to survive, it is how they thrive, and your veteran-owned small business is no exception.

It can be intimidating when determining how to finance that growth, but it doesn't have to be.

Armed with research and knowledge on business trends, growth, financing, and all of the options available to veteran-owned small businesses, you can make an educated decision on the best approach to financing your company's growth.

Let’s dig into three ways to finance your small business: self, equity, and debt financing. You can also download our handy ebook “The Basics of Small Business Financing” for a more in-depth look at your options.

Self-Financing

Self-financing means using your own money to grow your company, while never taking on partners or debt. While it’s great way to retain control and keep profits in your pocket, it is often not an option for a small business owner.

This leaves you with: equity financing and debt financing.

Both options have pros and cons, so let's look closer at each one.

 

Equity Financing

With equity financing, you’re shopping for investors to buy part of your company while still remaining a partial owner. It's the process of raising capital through the sale of shares of your company. Unlike a business loan where you must pay back the balance with interest, the investor gets shares in the company in the form of common stock, a share of the profits, and typically, the voting rights associated.

Download "The Basics of Small Business Financing."

Let's look at the pros and cons of equity financing.

equity-financing.jpgPros:

  • The investor can recover his or her investment from profits, so there isn’t a business loan payment or interest.
  • Investments typically aren’t required to be paid back at all, so if your company folds, you likely aren’t on the hook for their money.
  • Investors with experience have exactly that: experience. The right investors can (and should) help a company grow by offering more than just money.
  • The burden of decision making is split up between you and your investors, which can be especially helpful with the right investors who have the right connections within your industry.

Cons:

  • With the addition of Director level decision makers comes the loss of control. Selling part of your business means you’re bringing on an executive or Board level partner with rights comparable to the percentage of the company they purchase. Say they invested in 20% ownership in your company, and you had four additional investors at that level, you now have five decision makers with equal voting rights. This means you risk getting outvoted when it comes to decision making.
  • Getting equity financing can be time consuming. Pitching to investors and venture capitalists takes time, as does completing due diligence, negotiating contracts and ownership rights.

See also: How to Understand Business Loan Rates and Fees

 

Debt Financing

Learn the Basics of Small Business FinancingYour other option is debt financing. Debt financing is typically a business loan or line of credit from a lender with interest, similar to a mortgage or car loan.

Just like equity financing, debt financing has its own pros and cons. Depending on the amount you need, your business financials, and where you go to ask for a business loan, your experience can be wildly different. Typically whether you go to a bank or an online lender, you'll need to submit financial documents to prove your cash flows and credit worthiness. With a bank, it typically takes longer because the processes were designed around paperwork and regulatory burdens require significant information requests. But with an online lender, it can take just a few days because they have streamlined the process without the paperwork.

Pros:

  • You’re in complete control of your company. By taking out a business loan, you’re paying principal, interest, and sometimes other fees in order to retain control of your company and your profits.
  • A business loan eventually ends, once you’ve paid it back.
  • Though business loans do come with different terms and conditions, you’re generally free to spend the money on your company as you see fit.
  • If you’re organized, have great cash flows, and are creditworthy, it can be pretty simple to get approved for a small business loan.

Cons:

  • Interest. Interest can be a drag on the bottom line every time you cut a check to your lender.
  • You'll need to be organized and provide your financial statements and other business documents as required. Though, let’s be honest, you should be doing this anyway.
  • Sometimes what you ask for is not what you get. This will depend on your business loan application and the financial health of your business.
  • Some business lenders run personal credit checks. (StreetShares doesn’t put a hard inquiry on the credit bureaus.) 
  • If you get denied, other lenders may be able to see when credit checks were run and base their decisions on that information.
  • If your business fails, and your business loan isn't repaid at that time, lenders could have rights to your company’s and sometimes your personal assets.
See also: How to Determine Your Small Business Financing Needs

 

Equity or Debt?

Now that you have the basics on financing your company’s growth, it’s time to decide which financing option is best for you and your company.

To help you make a well thought out decision, ask yourself five questions: Who? What? When? Where? Why?

Who? Lenders or Investors.

Get Flexible Funding for your Small BusinessIf you don’t mind giving up control for help, then an equity investor is a good option. But if you absolutely, under-no-uncertain-terms, would consider letting someone else make a business decision for you, a lender is what you’re looking for.

What? Money.

Are you looking for more than just money? Are you looking for someone to shoulder the responsibility with? Someone whose strengths cover your weaknesses and vice versa? If you just need money, a small business lender is the way to go. But if you’re also looking for help in your company or particular industry, an investor might be your better option.

When? Timing.

Do you need the money now? Do you have time to wait? Debt financing can be quick. An online lender can often have a decision back to you in a matter of hours. Finding the right equity investor can and will take time.

Download "The Basics of Small Business Financing."

Where? Grow big or grow home.

How much growth are you looking for? Global? Just a bigger office space? Something in the middle? Investors typically look for companies with the plan (and potential) to grow big, in order to recoup and profit from their investment. But if your plan is to grow home and have a sustainable and profitable business, instead, a lender might be a better option. There isn’t anything wrong with wanting to stay local, as local gives a small business the benefit of community support.

Why? Growth.

Keeping in mind that this entire decision is based on your plan to grow your business, ask yourself whether you can grow it the way you want with someone sharing in the decision making process. If so, an investor is a good option. But if you’re sure you won't have the freedom to take your company in the direction you want to grow, then a lender is what you want.

 

Small Business Financing - It's Your Choice

Ultimately, financing your small business is usually a personal and business decision, and now you have the tools needed to make the best choice for your company. If you're interested in debt financing and are ready to apply for a small business loan, click here. If you have any questions about this topic, we would be happy to chat. Just contact us here. Want to learn more about financing your business? Download "The Basics of Small Business Financing" to get the complete picture.

Learn the Basics of Financing

 

Topics: Funding Your Business, Veteran Small Business

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