Choosing Between Debt Financing or Equity Financing

Finance managers world over are faced with the choice between debt financing and equity financing when looking for finance for their businesses. Both the types have certain merits and demerits. A little demystification will perhaps help towards the decision making process.

Debt financing the pro’s and cons

Debt financing is basically when you take loans from financial institutions, banks or government agencies which need to be repaid over a fixed time period. Debt financing has certain advantages and disadvantages, which are listed below.

The positives

The lending institution or bank has no say in the internal decision making of the business and has no ownership in the business. There is a tax advantage since the interest on the loan is tax deductible and you can usually plan and incorporate the repayment in your budget since both principal amount and interest rate are known.

Disadvantages:

Loan repayments may be used for working capital and cause cash inflow issues ultimately affecting growth.

Flexibility with regard to repayment time is mostly non-existent.
Too much of debt may cause your business to be identified as high risk entity and hence negatively affecting prospects of raising additional capital in the future.
Your business may become vulnerable if your cash flow is affected owing to several reasons, such as drop in sales. This is especially true for new businesses
You may have to provide assets of the business as security or collateral.
Equity financing

Equity financing is when an investor finances your business in exchange for ownership of shares or stakes in the business. The investing entity reclaims the investment from future profits. The advantages and disadvantages of equity financing are as follows:

The positives

You don’t have to repay the money and hence it is less risky than a loan.
You can access the investor’s network, adding more credibility to your business.
Your working capital is not affected due to loan repayment compulsions and business growth gets a boost.
In case the business fails, you don’t have to repay the investment.
Disadvantages

Loss of autonomy since the investor has certain control over the functioning of your business and also shares your profit.
You will have to consult the investor while taking decision, which may result in disagreements and friction
At times the returns taken by the investor may outstrip interest rates payable on loans.
Finding an appropriate investor is both time and resource consuming.

Financing Sources and Types to Ensure Successful

Money is of extreme importance nowadays. Almost
everything that we do involves money. The same is true
if one wants to venture into business or buy a home
which is one of the basic needs for survival. Financing
or supplying of funds in business is a must to make it
grow and achieve the desired expected profit (together
with the right planning and managing). Common mistakes
encountered by new entrepreneurs are wrong financing
sources, underestimated amount needed for capital and
inflexible financing types. These problems however can
be prevented by careful planning and analysis of the
various factors involved in starting a business.

In general, business people can choose from the two
types of financing, the debt and equity financing.
Equity financing is the type commonly used by small or
growth stage entrepreneurs. The sources for this type
involves the center of influence that trusts the
entrepreneur, such as friends, relatives, family
members and other people interested in investing their
money in the business. However there are also
capitalists who are ready to take the risk of financing
small businesses. These capitalists may include
financial institutions, authorized government agencies
or well-to-do individuals in society. There are also
venture capitalists that finance new business in the
industry to get equity. Businesses that have been in
the industry from three to five years are preferred by
venture capitalists. They have various methods to
manage or deal with the businesses that use their
financing or invested money. They can influence the
decision making policies of the business in the event
its performance does not come up with the expected
result.

Another general type of financing is debt financing.
This type has varied sources which include Small
Business Administration Loans, commercial loans through
banks and personal loans from family, relatives and
friends. The government recognizes the importance of
business in the economy of the country and that is why
they offer programs that can encourage the growth of
small enterprise by having their own financing agencies
tp help a lot of young business people and
entrepreneurs. Debt financing through banks is the
traditional means to fund a business. The banks act as
a short term lender for the business person to have the
needed money to buy equipment and machineries necessary
for the business to flourish. The SBA or Small Business
Administration Loans are used in the case of local
banks. The loan that can be acquired can be from $5,000
to $2,000,000.

From these two general types of financing branch the
various kinds of financing involved – not just in
business but in other fields as well. A few of which
are piggyback financing, owner financing and creative
financing. Piggyback financing is used by home buyers
who want to avoid mortgage insurance which is required
when the mortgage is more than 80 percent of the
purchase price. Through piggyback financing, the
borrower can have two mortgages with costs that may
vary. Owner financing happens when the owner or seller
of the property is the one financing the buyer so in
this case the owner acts as the bank. The buyer in turn
can pay the needed amount monthly or whatever may be
the agreement instead of going to the bank for
financing. Creative financing happens when the house
buyer has a third party lending institution which can
be a bank or a loan agency.

Why Early-Stage Startup Companies Should Hire a Lawyer

Many startup companies believe that they do not need a lawyer to help them with their business dealings. In the early stages, this may be true. However, as time goes on and your company grows, you will find yourself in situations where it is necessary to hire a business lawyer and begin to understand all the many benefits that come with hiring a lawyer for your legal needs.

The most straightforward approach to avoid any future legal issues is to employ a startup lawyer who is well-versed in your state’s company regulations and best practices. In addition, working with an attorney can help you better understand small company law. So, how can a startup lawyer help you in ensuring that your company’s launch runs smoothly?

They Know What’s Best for You

Lawyers that have experience with startups usually have worked in prestigious law firms, and as general counsel for significant corporations.

Their strategy creates more efficient, responsive, and, ultimately, more successful solutions – relies heavily on this high degree of broad legal and commercial knowledge.

They prioritize learning about a clients’ businesses and interests and obtaining the necessary outcomes as quickly as feasible.

Also, they provide an insider’s viewpoint and an intelligent methodology to produce agile, creative solutions for their clients, based on their many years of expertise as attorneys and experience dealing with corporations.

They Contribute to the Increase in the Value of Your Business

Startup attorneys help represent a wide range of entrepreneurs, operating companies, venture capital firms, and financiers in the education, fashion, finance, health care, internet, social media, technology, real estate, and television sectors.

They specialize in mergers and acquisitions as well as working with companies that have newly entered a market. They also can manage real estate, securities offerings, and SEC compliance, technology transactions, financing, employment, entertainment and media, and commercial contracts, among other things.

Focusing on success must include delivering the highest levels of representation in resolving the legal and business difficulties confronting clients now, tomorrow, and in the future, based on an unwavering dedication to the firm’s fundamental principles of quality, responsiveness, and business-centric service.

Wrapping Up

All in all, introducing a startup business can be overwhelming. You’re already charged with a host of responsibilities in which you’re untrained as a business owner. Legal problems are notoriously difficult to solve, and interpreting “legalese” is sometimes required. Experienced business lawyers know these complexities and can help you navigate them to avoid stumbling blocks.

Although many company owners wait until the last minute to deal with legal issues, they would benefit or profit greatly from hiring an experienced startup lawyer even before they begin. Reputable startup lawyers can give essential legal guidance, assist entrepreneurs in avoiding legal hazards, and improve their prospects of becoming a successful company.