Debt and equity financing for your business

One of the first questions in every prospective business owner's mind is how they will raise the cash they need to start their business. It is important to stress that no matter what route you choose to finance your business a well-thought plan is crucial.A well-developed business plan is key before you go forward with obtaining financing. There are basically two types of financing that you can use to get your business started.These are debt and equity financing.Here is a brief overview of both-

Equity financing

You may start with some cash out of you own pocket when you are beginning your business. In addition you may also have family or friends who are interested in your business idea and they would like to invest in your business. That may sound really good on the surface to you, but even if this is the best arrangement for you, there are certain considerations you should take into account before you accept their offers. If you decide to accept investments from family and friends, you will be using a form of financing called equity financing. The first thing that you should be extremely clear about if whether your family and friends want to invest in your business or loan you some money for your business. That is a critical distinction! If they want to invest, then they are offering you equity financing and if they want to loan you money for your business, then that is quite different and is actually considered debt financing. There are certain advantages of equity financing that include:

1. You can use your cash and that of your investors when you start up your business for all the start-up costs.This is done instead of making large loan payments to banks or other organizations or individuals. You can get your business started without the burden of debt.


2. You will have prepared a prospectus for your investors and explained to them that their money is at risk in your brand new start-up business, they should understand that if your business fails, they will not get their money back.


3. Your investors may be able to offer valuable business assistance that can be extremely important in the start-up phase.

There are also some disadvantages of equity financing that should be considered as well.This includes:

1. You will need to remember that your investors will actually own a piece of your business.The piece of business they own will be directly propionate to the amount of money they have invested. Investors will expect a piece of the profit as soon as you start making one.


2. Since your investors now own a piece of your business, you will be expected to act in their best interests as well as your own, or you could open yourself up to a lawsuit.

Debt financing

If you decide that equity financing is not right for you then you may want to pursue debt financing in order to start up your business. You will probably want to try to tap your own sources of funds first by using personal loans, home equity loans, and even credit cards. Applying for a business loan is another option. There are certain advantages of debt financing that can include:

1. Debt financing allows you not to have to take on investors or partners and you make all the decisions and own all the profit.


2. If you decide to finance your business using debt the interest you pay on your loan is tax-deductible.


3. Your lender will not share in your profits all you have to do is make your loan payments on time.

It is important to keep in mind however that there are certain disadvantages of debt financing as well.These can include:

1. You may end up with large loan payments at precisely the time you need funds for start-up costs. If you do not make loan payments on time to credit cards or commercial banks, you can ruin your credit rating and make borrowing in the future difficult or impossible if your loan is from family or friends you can strain relationships.


2. Commercial banks may require you to pledge your personal assets before they will give you a loan. If your business goes under, you will lose your personal assets.


3. Studies who that the more debt financing you use, the higher the risk of bankruptcy.

You may be asking what is best debt or equity financing. The bottom line is that it depends on the situation. Your financial capital, potential investors, credit standing, business plan, tax situation, the tax situation of your investors, and the type of business you plan to start all have an impact on that decision.

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