Generally, when your business requires outside financing, there are two different sources of funds, debt financing or equity financing. Both methods of financing can have a significant impact on your business and should be considered carefully.
Most of us are familiar with debt, whether you have had a credit card, taken out a student loan, or financed a car. Debt financing involves borrowing a sum of money from a lender which is then paid back with interest. There are several types of debt financing available, and you should speak to a financial professional to explore your options. With debt financing there are some general pros and cons:
- There are a wide range of types, with different terms and interest rates
- You retain ownership of your business
- This type of financing can generally be used for all sizes and types of businesses
- Requires repayment of principle plus interest, whether business is good or bad
- Lenders can restrict what you use the money for and whether you can get additional financing elsewhere
- Lenders can establish covenants, such as a requirement to maintain certain financial ratios, that have to be met or the loan will become due.
Equity financing is not for every business. Equity financing is the sale of a percentage of your business to an investor to secure the needed capital. This type of financing generally comes from three sources: family and friends, private or “angel” investors, or venture capital firms. Despite the source, they will carefully analyze your business and its financials. They want to see a well thought out business plan, experienced management, clear pricing and more. So, what are the pros and cons of this type of financing?
- For new businesses with minimal revenues or those who have not yet been profitable, this might be the only financing option available
- No monthly loan or interest payments
- Investors will generally take on all the risk, as they will only get returns if your business succeeds
- You lose a percentage of your business
- Finding an investor is difficult and, if you find an investor, you will generally have to spend time sending them reports and financials
- Investors can have significant influence on the direction of the company and may even have control over key decisions
There are advantages and disadvantages with both types of financing. It is important that you conduct your research and consider the pros and cons before putting forth extensive effort into searching for financing sources. Ensure you understand which one will be most beneficial to you and your business, both in the short and long-term. Lastly, remember to consult with your legal counsel before entering these types of arrangements. Equity and debt agreements can be complicated so you will want to make sure someone is in your corner throughout the process.
Our professionals have many years of experience working with construction, dealerships, restaurants, nonprofits, governments, and technology industries. If you have an accounting question, don’t hesitate to contact a Henry+Horne professional adviser.