When considering raising money for a small business, entrepreneurs have a very important decision to make as to how they acquire capital. Perhaps the two most popular forms of fundraising for businesses are debt financing and equity financing. Each has different pros and cons associated with it, and it is extremely important that a business owner carefully considers which type of financing is right for their business.
Debt financing is what most people think of when they think of a loan. In debt financing, a business sells bonds, bills or notes to an individual or institution with the agreement that they will repay the principal plus an agreed-upon interest amount. Generally, as long as a business is able to grow with the money it is lent, paying the debt back is not a problem. Complications arise when a business is unable to pay the loan back and defaults. At this point, the lender may sell assets to pay their debt or declare bankruptcy.
Debt financing may be right for your company if you already have a steady, proven stream of revenue and expect that revenue to continue for some time. Well-established businesses looking to expand generally have the most success with debt financing options. Additionally, a willingness to take on debt signals to other investors that you are committed to your business and are confident that it will succeed.
A business finances through equity by selling stock in their company to a bank, investment firm, or the public. Once the value of a business is determined, there are a myriad of options to buy different kinds of stock, both common and preferred, in that business. The amount that a business is paid for each share is determined by how the business is valued and the type of share received.
Equity financing can be a great option for young companies without proven revenue streams who have a high risk of defaulting on a traditional loan. Some owners can be apprehensive about “losing control” of their business assets and complicating operations within their business. It is always important find a comfort level and balance in how you allot your equity for financing. Talking to your bank in depth about your current assets and your revenue milestones and timeline for reaching these goals is important in finding the right balance of equity and liability.
The decision to take on debt versus the selling of equity is a complicated one. Celtic offers advice to small business entrepreneurs and owners every day. Please do not hesitate to call us (801-449-1991) so we can help you make the best possible decision for your small business.
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