The pros and cons of funding your business through debt or equity

The pros and cons of funding your business through debt or equity. One of the most important business decisions is whether to bring in outside capital. Once a business needs funding (maybe your thinking about growing organically) the question inevitably becomes whether to choose debt or equity financing. Here are a few questions to consider when making the decision.

1.     When do you need the money?

If you need money right away, debt financing is probably the way to go. Debt is less complicated to set-up, and some types of debt can be secured in a matter of days.

2.     How much money do you need?

If you need a significant amount of money, you’re probably looking for equity financing. Not only is taking on a lot of debt risky, but most equity investors won’t even look at investments under £100k because it takes just as much work for less reward.

3.     How profitable are you?

The cost of taking on debt is dependent on your ability pay. If your business is profitable, it improves your creditworthiness and your ability to raise higher amounts of debt. If you’re not yet profitable or revenue producing, you may have difficulty convincing a lender you’re worth the risk. In which case an equity sale may be the only option in terms of raising cash.

4.     Do you need more than cash?

Often an equity investment in a company carries with it side advantages, links to potential partners, expertise from a new Board member or maybe a route to a future exit. None of these are available from a debt provider.

Our Key Checklist of the Pros and Cons of Debt vs. Equity

Debt

Advantages

  1. Doesn’t dilute shareholding
  2. No claim to future profits
  3. Interest obligations can be forecasted easily and accounted for
  4. Interest can be tax deductible
  5. Less complicated

Disadvantages

  1. Must be repaid
  2. Fixed cost so raises break-even point
  3. Must be budgeted for
  4. Sometimes contain restrictions, preventing other financing options/opportunities
  5. Pledge assets as collateral
  6. Sometimes owners asked to personally guarantee a loan

Equity

Advantages

  1. Freedom from debt
  2. Access to external expertise and contacts
  3. Follow up funding

Disadvantages

  1. Shared ownership
  2. Less control
  3. Potential of conflict between shareholder
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