Debt Financing vs Equity Financing: 4 Key Differences You Need to Know

Every growing business will reach a point where it needs to raise capital to support its expansion, and there are various ways to go about doing this.

Broadly speaking, the various financing options available to you can be divided into two categories: debt and equity, each of which has its advantages and drawbacks. If you're considering going down one of these routes, you should first have a thorough understanding of what each process involves and what it will mean for your business.

One of the most important things to remember is that your company is unique, and you should prioritize your specific needs and goals before committing to a particular course of action. It's also a good idea to compare equity financing and debt financing, to get a clearer idea of which choice makes the most sense for you.

1. Equity financing can mean less control over your business

Equity financing is the process of selling shares in your organization to raise capital, so if you choose to go down this route, you need to be prepared to relinquish a certain amount of ownership and control over the business.

All investors are different, and some will want to be more involved and have a greater say in how the company is run than others, but it's important to know that outside investment will come with certain conditions and expectations.

An extreme example of how this could unfold is if the company decides to sell more than 50% of its stock to investors, which will mean the original founders and owners no longer have majority control. Other shareholders will then have the power to make big decisions that will dictate the future of the business, such as making leadership changes.

Bear in mind that, depending on your plans and ambitions to achieve growth with investor support, bringing new voices and insights into the company can be a positive thing. Investors can act as mentors and connect you with resources and networks that you would have struggled to access on your own.

2. Debt financing may be more accessible

Where equity financing requires you to sell a stake in your company and potentially give up a certain amount of control, debt financing can be less complex and more accessible, in the sense that you borrow funds from an outside source and repay the principal amount, plus interest.

Debt financing can come in various forms, some of which even the least experienced businesspeople will be familiar with, including:

• Traditional bank loans: Subject to potentially strict credit checks, meaning they can be difficult to secure, but could offer lower interest rates than alternative finance.
• Business credit cards: Much like personal credit cards, but with additional features and benefits specifically for businesses.
• Lines of credit: Securing a flexible line of credit can be particularly useful if you want the option to borrow money as and when you need it, then repay the outstanding amount over a set period of time. It can help with covering frequent operating expenses such as payroll and inventory.

Equity financing can be a more demanding and complex process than borrowing funds to invest in your business. Debt financing will involve credit checks and examinations of the financial stability of the company, but equity investors will want to see detailed business plans, growth forecasts and impressive pitches before they think about backing you.

3. Equity financing could enable quicker scaling

If you're able to secure equity financing, one of the benefits you could expect to see is the opportunity to scale your business more quickly. Angel investors and venture capitalists have the financial power to provide a substantial injection of capital into your company, which could be crucial if your expansion plans rely on:

• Acquiring more raw materials and assets to step up production
• Hiring new staff
• Increasing your marketing spend

As noted in point one, equity investors supply funding in exchange for a stake in your company, so they have a vested interest in seeing the business grow and succeed. Consequently, they could be keen to support your efforts to expand by bringing your attention to new opportunities and passing on their own knowledge and advice.

4. Debt has to be repaid no matter what

Banks, business loan oan providers and other sources of finance will expect you to keep to the debt repayment terms outlined in your agreement, regardless of how the company is performing. If you're struggling to manage your cash flow, you'll still need to find a way to make your repayments if you want to avoid incurring penalty charges and damaging your credit record.

Taking on debt also comes with other financial risks, such as the fact that any assets you put up as collateral - your personal property, for example - will be at risk if you default on a loan.

Equity financing, on the other hand, gives you the benefit of time. Angel investors and venture capitalists will want to see returns on their investment in the long term, but unlike banks, they will be prepared to wait until the company is profitable before expecting their money back.