If you want to start a business and do not have the cash reserves to do so, you will need some sort of financing. There are many options, including:
- Bank loans
- Alternative loans
- Venture capital
With all of these options, it can be hard to choose the best one.
First of all, you need to understand that there are two broad categories:
- Debt financing
- Equity financing
The best way to determine which is best is by learning more about what they are and weighing the advantages and disadvantages of each.
Defining Debt Financing
If you’re like most people, you’re familiar with how a loan works. Debt financing is basically the same thing. You accept funds from an outside source and make a promise to pay the principal plus interest. This is the “cost” of the loan.
The borrower puts up collateral as an assurance to the lender and makes monthly payments toward the loan. Collateral may be accounts receivable, inventory, insurance policies, real estate, and more. If the borrower defaults, the lender take possession of the collateral.
Common Types of Debt Financing
The most common types of debt financing are:
- Conventional bank loans
- SBA loans
- Merchant cash advances
- Lines of credit
- Business credit cards
Advantages & Disadvantages of Debt Financing
There are several advantages and disadvantages associated with debt financing. The top advantages are:
- Clear, finite terms
- Lender is not involved in company operations
- Interest payments are tax-deductible
The top disadvantages are:
- High repayment/interest fees
- Repayments start immediately
- Potential loss of collateral
Defining Equity Financing
Equity financing, on the other hand, involved selling a stake in your company to investors who will share in your future profits. There are several ways that you can obtain equity financing. If you choose this route, you don’t have to make regular installments and you don’t have to deal with high-interest rates. Instead, the investor will be part owner of your business, meaning they have a right to a portion of your profits and possibly a spot on the board.
Common Types of Equity Financing
The most common types of equity financing are:
- Angel investors
- Venture capitalists
- Equity crowdfunding
Typically, angel investors and venture capitalists are experienced and discerning. They do not back just any project. In order to convince them to consider funding your business, you must have a pro forma with solid financials, a prototype of your product/service, and a management team. If they are not already in your network, it can be hard to find them.
While you do not have to make interest payments, the overall cost of equity financing is often higher. Equity holders want to be compensated, which typically means paying dividends or ensuring equity price appreciation.
Advantages and Disadvantages of Equity Financing
There are several advantages and disadvantages associated with equity financing. The top advantages are:
- Ideal for start-ups in industries that are growing rapidly
- Allows for rapid scaling
- No repayment until company profits
The top disadvantages of equity financing are:
- Difficult to obtain
- The investor is involved with company operations
Which is best for your business? In order to decide which is best for your business, you must consider the type of business you have and if the advantages outweigh the disadvantages. Research what type of funding your competitors are using. Most companies use a combination of the two. If you need help determining the best financial solution for your business, contact My Commercial Capital right a