Tuesday, October 3, 2023

Distinguishing between debt financing and equity financing – advice from Saivian Eric Dalius

Easy availability of finance is key to business growth and especially important for starting up a business. Among various funding options, entrepreneurs have to choose between borrowing money and selling some business equity in exchange for finance. Although borrowing is the most traditional method of business funding while holding on to the ownership of the business, the other options of selling the stakes in the company to arrange for finances is also quite popular, confirms Saivian Eric Dalius

In the end, it all depends on the type and size of the business and the growth plans to decide which type of funding should help to realize the business goals.  Small business owners must adequately understand the two methods of financing known as debt financing and equity financing to decide which would be suitable for them in a given situation. 

Debt financing explained by Saivian Eric Dalius

Any type of fundraising by borrowing money comes under debt financing. The borrower avails some loan by providing collateral security to the lender and pays back the loan in monthly installments over a specified period. The repayment comprises a part of the principal amount together with the component of interest that keeps reducing with each payment. The applicable interest can be either fixed or floating, as chosen by the borrower.  

Although the monthly payments are for a fixed sum, the principal and interest components keep changing to ensure that the payback period remains unchanged. Collaterals accepted by lenders include real estate, inventory, accounts receivable, equipment, or insurance policy. If the borrower falters in loan repayment, the lender can use the collateral to recover the due amount. 

All types of loans like traditional bank loans, SBA loans, lines of credit, merchant advances, and business credit cards form the bouquet of debt financing instruments. 

The lender cannot interfere in the business operations, and the fixed monthly payments allow better debt control through proper budgeting. Moreover, the loan interests qualify for tax deductibles that lower the burden of income tax. 

Equity financing

Business owners who are ready to invest in exchange for funds provided by companies or groups like the Venture Capitalists (VCs) or individual investors known as Angel investors are availing Equity Financing. The arrangement consists of business owners selling some equity or shares of their business to the funding agency or individual and allowing them to control the business. Equity crowdfunding means accepting money from several lenders in exchange for business equity.  

However, it is not easy to arrange funds in this manner unless the business shows good prospects of growth because the investors would do enough due diligence to ensure that they put in their money at the right places to get the right ROI.  Businesses with solid financials, stable products or services, and a professional and qualified management team are investors’ first choices.

By allowing the investors to participate in the business, the business can grow faster with the advice and expertise of the lenders who are keen to ensure a quick return on their investments. 

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