Financing: Debt Versus Equity

by Greg DePersio

2 min read

Small businesses have a number of options for raising capital to fund future growth. The most common is taking on debt in the form of a loan from a bank or other institution. Offering investors equity in your business is another alternative for obtaining cash, although that is a much different form of funding than a loan. Each option has its advantages and disadvantages. The financial health of your company and how you plan to use the cash may make one choice better than another.

Equity Dilutes Ownership

When you sell equity, you’re giving up ownership of your business. That has implications both financially and with regard to your company’s daily operations. When you give up a share of your business in exchange for cash, you may never reacquire that stake again unless the shareholder is willing to eventually sell it back to you. If you need to sell equity more than once, you could dilute your share of the business down to the point where you no longer own the majority. If this is the case, your shareholders could make decisions for your company without necessarily needing your approval. Debt requires no such sale. You retain 100% ownership in your company.

Debt Needs to Be Paid Back

Taking on a loan for your business is just like taking a mortgage out on your home. You receive the loan amount with the promise that you’ll pay it back in instalments with interest until the loan is paid off. In the end, it adds to your company’s monthly expenses, and this can affect how flexible your business can be in the future. Taking on too much debt can negatively impact how your business operates, and can affect your ability to acquire additional funding. Equity financing requires no repayment. You’re simply selling part of your business in exchange for cash.

Debt Puts Your Personal Assets at Stake

In the case of equity financing, much of the risk lies in the hands of the investors. If your business fails, they stand to lose their entire investment, but you, as the business owner, don’t owe them anything further. When applying for a loan, the lender will often require that you put some type of asset up as collateral in order to approve the financing. If you fail to pay back the loan, the lender can take the collateral. For example, if you put your house up as collateral, you could potentially lose your home if you default on the loan.

Equity Financing Can Be Difficult to Obtain

Outside of traditional banks, there are a number of lending institutions and government agencies willing to help small businesses. In fact, the terms of these loans can often be more favourable for the business owner. Obtaining equity financing can be trickier. Many venture capitalists and angel investors will only consider larger businesses in which they can exert more influence and have greater potential. Your small business may not be big enough to attract the attention of these parties.

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