Knowing Your Business Funding Options: The Difference between Debt and Equity
Posted by bloggerpds on June 18, 2013
Business fundingWhen it comes to business, money makes the world go round. The money going into the business is what gives the company the power to expand and make an impact while money being spent by the business is the necessary cost of achieving expansion and impact. Normally, money is produced within the company, or the company uses its own resources to progress at a faster rate. However, a company can expand and grow over a shorter period of time even if it doesn’t have the money on hand if it avails of external business funding options.
As alluded to previously, external funds are availed of when the company needs more money than it can get from its own income or bank accounts in order to make the company grow. The main goal of external business funding is to create returns on investment bigger than the expenditures spent on the external capital. Otherwise, the company will likely need to avail of credit repair services or even go into bankruptcy in order to pay off the costs incurred.
There are two main ways external funding can be procured – through equity investment and through accepting debt in the form of business loans. Both sides have their advantages and disadvantages, and it is important to balance out the good with the bad before making a decision to avail of external funds.
Equity is when the company receives outside funding from investors, who receive a percentage of the company in return commensurate to the amount of money invested. It is typically used by companies when they are just starting out. This is because when a company is first created, it has no savings to back itself on or to spend on business loans. Equity is advantageous because it pays off for equity investors for as long as they hold onto their shares. It can also give equity investors the power to participate in the decision making process of the company and even hold power in the Board of Directors. Both of these advantages make it much easier for companies to find business funding because many people are happy to make money through their shares and hold partial ownership of a business.
Equity has a few disadvantages as well. It doesn’t work too well with risky ventures since equity investors have the possibility of losing everything if the business goes belly up and isn’t secured. It is also a lot pricier to do than taking out a loan, and can put the company in jeopardy if too many investors pull out at the same time.
Debt in the Form of Business Loans
Contrary to common belief, debt is a positive thing for businesses. It is when the business takes out a loan from a bank or from an investment fund, with the promise of paying it back in installments later on. The interest on the loan and the amount borrowed is based on the history of the company and risk that the lender has to take. Many businesses take on business loans because of its advantages. It is typically much cheaper than equity and allows the company to remain under a single group of owners, rather than dividing the power amongst different investors.
On the other hand, debt based external funding can be very difficult to avail of. If the business has had to use credit repair services in the past because of bad credit or has not proven long-term profitability, many lenders will not give the business a loan. If the company is unable to pay the loan, the owners may lose more than simply the business – since many business loans are collateralized, they may also lose their property.
At the end of the day, external business funding can either boost business growth, or it can send its owners into personal debt and send them looking for credit repair. Depending on the business and the financial situation, the company should decide whether to use equity or debt, or if to use external funding at all.