Factors to Consider When Selecting the Appropriate Financing Option

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debt and equity financing

Startup capital is hard to come by. Even with your savings, you will soon realize that you need a capital boost and that is when you will have to choose between the two common means of funding — debt and equity financing.

What are these two funding options?

Essentially, what these two options ask is whether you (1) need to take a loan for capital or (2) get an investor willing to invest in your company. Either option has significant business consequences, hence the thorough considerations.

Under debt financing, you will borrow money from a lender at an interest and you will be expected to repay the money after an agreed duration. On the other hand, equity financing is where you trade the ownership of your company for investment funds. Often, equity investors include venture capitalists and angel investors.

As a result of the disparity associated with these business financing options, you cannot get funds from either source blindly.

Before signing any agreements, keep in mind the following factors:

1Amount needed

How much capital does your business need? The amount of capital required by your business will always determine the means of raising the money. It doesn’t make sense to look for a venture capitalist when your business needs only a small financial injection. Therefore, when in need of a small amount in capital, debt financing is the best alternative.

Venture capitalists and other investors make big investments and it is a financially sound decision to look for them when in need of a big sum of money.

2Urgency

Loans are viable funding solutions when in urgent need of funds. Although there are associated costs, the urgency of the need supersedes the associated transactional fees making debt financing a great approach. Some of the easily available and affordable debt financing options include SBA loans or borrowing from peer-to-peer lenders online.

In the meantime, all forms of equity financing require time. You have to find the investors, pitch your business to the investors, prepare financial projections, draw up legal documents, and convince the investors to invest in your company. Equity financing is therefore the best alternative when looking for funds to use in growing the business later on.

3Other needs besides money

Are you looking for something other than a financial boost? Do you have big expansion plans? Do you foresee rapid growth in business and are in need of a big boost? You need equity financing.

Equity lenders often look at a business’s potential for growth and how they can make greater returns for their investments. If you foresee this and are looking for financing to get you there, then you need to start your search for equity lenders. You will need to prepare a comprehensive business plan, detailed financial projections, and reports of the business history. These are essential for venture capitalists or angel investors but unnecessary in debt financing.

For equity financing, you also need to have a strong management team, a strong marketing acumen, and passion for your business. These will help in convincing the investors and also require a lot of time.

Although venture capitalists own a stake in your company, they will offer excellent and professional advice and guidance to your business meaning that you will avoid unnecessary pitfalls and mistakes. Equity investors are highly experienced and they will be the best mentors for your business.

Just like many other millennials running startup businesses, you may find yourself ridden with student loans and other debts. Besides providing help with the business, equity lenders will guide you on how to get control over the many debts. The most effective and the commonly advocated debt management strategy is debt consolidation.

The option of debt consolidation gives control over repayments by reducing the number of loans payable monthly and also the amount payable monthly at the end of the debt repayment period. With the lower interest rate charged on the debt consolidation loan, you will be at a better position to manage your debts and expenses. Besides personal loans, debt consolidation is an effective debt financing alternative for student loans, outstanding creditor bills, and credit card debt.

4Sharing your company

If you are looking for a big investment from venture capitalists, then you should come to terms with the fact that you will have to share your company with an investor. If sharing ownership and the profits of the company doesn’t auger well with you, then, debt financing will be your option. You should note that a loan may not be enough to get you the necessary funding.

When in need of expertise and the guidance of an equity investor alongside funding, then, you will have to clearly highlight that fact and ask for funding to be repaid.

Besides getting bank loans and asking for mere funding from investors, you can take advantage of platforms offering crowdfunding. You should also consider talking to your friends and family, or get loans from non-governmental institutions, microfinance organizations or even getting the affordable government loans. There also are accelerators for startups that one can benefit from.

5Interests and fees

When taking the debt financing option, you have to keep in mind the interest rate charged and the associated transaction fees. The rate charged is determined by your credit score. With possible high debts from business and personal loans, as well as your student loans, you may be considered a risky borrower. In this case, your loan application could be declined or approved at a high interest rate.

While considering debt financing, look at the repayment terms. Be smart, get the lender’s amortization schedule, and determine if the loan will be expensive or affordable at the end of the repayment period.

In conclusion, your choice will depend on your personal interests, the urgency of funding, the cost of funding, and future implications on the growth of the company. Finding the appropriate financing option has lasting effects in how your business runs after financing. In some cases, a business may even need both funding options for success.

See Also: 5 Ways Business Investment Loans Can Help Your Start-Up

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Author: Barrack Diego

Barrack Diego is a managing director at a renowned online lending institution. Check out his profile and blog for insights on options of debt consolidation, debt financing, alternative funding options, and management of student loans.

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