Debt v. Equity — What’s the Best Way to Raise Money for Your Expanding Business?
When it comes to raising money for your business, there are two primary resources available to you, debt and equity. These two categories can be broken down further, but all avenues of acquiring capital needed for expansion fall into either the debt or equity category. Learn about the best way to raise money for your expanding business.
What Is Debt Financing?
Debt financing is a way to raise money by selling debt instruments to investors, or simply, raising money by taking out a loan. This is most commonly done through a bank or some other financial institution, and the loan is granted on the promise that it will eventually be paid back. Often, this debt comes with an interest rate that must be paid back as well. US Capital Global is one of the best examples of corporate financing institutions that can help expanding businesses grow with manageable interest rates.
Taking out a loan requires some kind of exchange of debt instruments. This typically takes the form of bonds, bills, notes, or any kind of fixed income product. This can be a particularly good deal for the financier since there are assurances that the debt will be repaid in the future. Even if the company goes bankrupt and the loaned money doesn’t transfer to profit, the lenders will have a higher claim on seizing liquidated assets than the company’s shareholders.
What Is Equity Financing?
Equity financing is a way to raise money by selling shares in a company to investors. These investors can be private or public if the company is traded on the stock market. Equity financing requires a bit of a balancing act to take advantage of properly. On one hand, it’s relatively easy to get money for expansion by selling shares, but the fewer shares you have, the fewer rewards you’re able to reap when profits eventually come.
Since equity financing is trading shares in a company, there’s no expectation that the principal sum is paid back, as you’ve already reimbursed your investors with shares in the company. Instead, your investors gain benefits from company profits as a whole in accordance with the percentage of shares they own. That also means that you won’t be able to collect as much profit personally since your company has multiple owners after selling shares.
Debt Financing and Equity Financing in Action
Imagine you’re in charge of a business and need about $50,000 in financing for expansion. Should you opt for the debt financing route, you can take out a loan of $50,000 from a bank. Imagine that loan comes with a 10% interest rate. If you end up making $30,000 in profit the following year, you’ll have to pay the 10% interest rate on the loan, which would leave you with $25,000 in profit for yourself.
With equity financing using similar profits, the outcome is a bit different. Imagine that instead of taking out a bank loan for $50,000, you sold 20% of your company’s shares for $50,000. If you make $30,000 in profit the following year, you wouldn’t have to pay any interest at all. You’d only be entitled to 80% of that $30,000, however, leaving you with $24,000.
Advantages of Debt Financing
While the specific details of your company profits and interest rates can alter the outcome significantly, there are some general advantages you can expect from debt financing. The most important advantage is that you don’t have to relinquish any claim to the business. All the shares remain firmly in your control, so you retain authority over the business itself.
Additionally, the loaner has no claim on the business’ future profits. If they far outweigh the value of the initial loan, the only debt that’s actually owed is the initial loan plus interest. Variable-rate loans can alter this standard a bit, but most loans can be planned for and aren’t contingent on your success.
Advantages of Equity Financing
With equity financing, there are several advantages to consider. First, you don’t have to pay anything back. The transaction is already complete. You were paid for sold shares. Additionally, you don’t have to worry about pledging any assets to someone who buys shares. Instead, the owners of the company would get the first claim to the company’s assets in the event of bankruptcy.
Interest rates can bury companies if not handled correctly. The mere existence of interest payment will raise the entire company’s break-even point, and that can increase the risk of insolvency during periods of financial hardship. Plus, the greater one’s debt-equity ratio is, the riskier they are to other lenders and investors.
Both debt financing and equity financing have their advantages and disadvantages, so the best strategy for raising capital for business expansion will vary by circumstance. You’re free to engage in both strategies simultaneously if that works best for your company. Are you ready to raise capital for expansion? Invest in debt financing or equity financing today!