Small businesses have to develop appropriate funding strategies for their growth in order to survive in the competitive market. The success of the business relies on the combination of expertise, manpower, and funds. It is well established that businesses can only bring-in expertise and manpower only if they have sufficient cash reserves. Shortages of cash flow cripple the business and affect its performance for a longer period of time.

Financing a business involves taking vital decision related to selecting the best option from amongst equity or debt financing as it can have big consequences on your business. Debt financing is a popular funding option as it involves procuring the funds through business loans. Equity financing is done by giving proportionate ownership to the potential investors in exchange for funds.

Let’s discuss the difference between debt and equity financing for assisting you to make an appropriate financial choice:

Urgent funding requirements

In case if you have urgent cash requirement for the smooth functioning of the business operations, getting a loan from banks or licensed moneylenders is the best option. This is because equity financing involves a lot of hard work as investors study the potential of your business to generate profits and legal agreements have to be drafted as part of the business funding process. On the other hand, you just have to submit certain documents for availing a loan and in a few cases, loans are approved within minutes.

Amount of funds required

For smaller amounts, debt financing is a good option since investors prefer funding larger amounts in order to reap maximum benefits. However, if the requirement is bigger, the equity funding option is beneficial as banks or lenders have a maximum limit which they can fund through a loan. Equity financing enables to raise huge capital without any collateral whereas certain assets may have to be attached as security for repayment while applying loans for higher amounts.

If the requirement is not just the funds

As the business expands, involving experts can be beneficial as they provide appropriate guidance while making important decisions. Since investors have the relevant experience, equity funding will enable to involve experts in the management and utilize their knowledge for increasing operational efficiencies.

Sharing the profits

Few entrepreneurs prefer to keep ownership with them and control all the aspects of the business. In this scenario, equity financing is not the right option since entrepreneurs lose certain control over the business because investors are involved in the decision-making process. Also, as an entrepreneur, you may have unique ideas which you want to explore but investors may not have the confidence in such endeavors, hence, conflict of interest may arise.

Future growth prospects

Angel investors and Venture Capitalists always look for businesses that have the potential of creating a brand in the national and international level. If you have the ambition of creating a huge brand, equity funding will help you to realize this objective. Angel Investors prefer investing in new businesses that face funding issues initially but have the potential of expanding in the future. They are focused on helping small businesses with their initial set-up without expecting profits for a certain period of time. Thus, they provide more favorable terms when compared with other lenders.

Venture Capitalists (VCs) fund small businesses that have the potential to expand and take risks investing in such firms for earning huge returns on their investments. They study the growth opportunities of the business before pooling the resources in exchange for a sizable stake of equity. The funding is provided to those firms that are at the stage where they look to commercialize their business idea. The VCs buy a stake in the firms, nurture their growth, and ensure they get substantial Return on Investment (ROI).

Crowd funding is the latest trend which enables to reach to the public using the Internet to raise capital through an online platform. The crowd funding websites can be used for communicating the benefits or rewards in exchange for investments such as providing a stake in the ownership.

Selecting the best option

The decision related to debt vs equity financing depends on the amount of funding required, the urgency of the situation, and ability of your business to take risks. While making the decision related to financing the business, it is best to construct a trade-off between the factors; getting a business loan is easier and business operations can be controlled as per your discretion. But the effectiveness of procuring funds through loan depends on the interest rate charged and extent of financial objectives achieved through the approved loan amount.

Finding potential investors is a tedious task and even if they agree to fund the business, they demand a substantial stake in the ownership. Although their guidance is valuable for future growth, entrepreneurs have to share a portion of control with the investors.

The combination of debt and equity financing can also be explored according to the business needs for greater flexibility.