Debt financing involves taking out a loan from a bank, a financial institution, or possibly a friend/family member that you promise to pay back. You agree to pay this money back at a certain date, along with interest. The lender will make their profit from the interest that you pay.
Advantages of Debt Financing
- The lender does not have any ownership in the business and has no say in how the company is run. As long as you make your payments on time, the lender is satisfied.
- Interest paid on debt financing is tax deductible.
- Since loan payments are predictable from month to month, you can accurately forecast how much money you will need to set aside each month.
- Once you make all of your loan payments, you owe nothing further to the lender.
- You can choose between short term and long term loans.
Disadvantages of Debt Financing
- You’ll need to start paying back your loan right away, which reduces how much cash you have on a monthly basis. If you go through a period where the business hits hard times, you still have to pay off your loan.
- A company may be required to pledge assets of the company to the lender as collateral, as well as some lenders requiring personal financial assets as part of the collateral.
- As you will see below, equity financing does not have interest payments, so this is a disadvantage for those interested in debt financing.
Equity financing involves receiving money from an investor in exchange for part ownership in your business. This investor will be entitled to a share of the business’s profits over time.
Advantages of Equity Financing
- Investors take all of the risk. If the company fails, you do not pay the money back.
- You will have more cash on hand month to month because there are no loan payments you are responsible for, allowing you to expand the business.
- Investors don’t expect a return on investment immediately.
Disadvantages of Equity Financing
- The biggest disadvantage, and something that may sway you away from equity financing, is that you are giving up a portion of your business. Depending on the agreement you have with your investors, they may have a say in day-to-day operations, and a say in how they want the money they invested to be spent.
- In the end, what you give up could be more than the rate you would pay for a loan, because you will be required to pay your investors their share of the profits unless you buy them out (which would likely be more expensive than the original amount of money they gave you).
- The process to find an investor can be exhausting compared to a loan which is generally a straightforward process.
- Investors will want regular reports about how the company is doing, something not required if you were taking out a loan.
There are advantages and disadvantages of both debt and equity financing. If you are interested in debt financing, AmOne can help you find the business loan you need. Just fill out a form on our website and you will be presented with the best business loan options for your situation in your market area.