Owning and operating your own business is part of the American dream, but if it was easy everyone would do it. You need ambition, dedication, and some form of financing. Debt financing could be more beneficial to your business. You might have a great product or service that people love, but you need the financial resources to get across the finish line to success. That could be in the form of a loan or using your own savings to invest in your business.
Most companies use a combination of debt and equity financing to establish or grow their business. While there are benefits and drawbacks to each type, debt financing gives your business flexibility and fewer restrictions.
Take a look at why debt financing could be better than funding your business with only your equity.
Equity Financing
Equity financing simply means using the cash you have on hand for your operations. This could be your own cash or an investor’s. While this may be your natural inclination, cash-flowing startup or expansion with solely your own cash can come with some downsides that can negatively affect your business.
If you’re only using the money that you currently have, you may not have the funds to fix an issue when it comes up suddenly. If you do decide to seek outside funding through investors, you’ll have to give the investor a percentage of your company. They will share your profits and you may need to consult with them any time you make decisions affecting your business.
Down the road, if you decide you want to remove your investors from the equation, you’ll need to buy them out. Unfortunately, while you’ll gain complete control over your business again, this will likely be more expensive than the funds they originally provided due to accrued interest.
Debt Financing
With debt financing, you’re borrowing money for your business’ short- or long-term needs. Banks and Community Development Financial Institutions (CDFIs) believe it’s better to get a loan to pay for a business’ long-term needs. This could be for new equipment, expansion costs, startup resources, etc. Likewise, a line of credit can cover the short-term costs of operating your business, such as salaries and inventory, for periods when monthly business revenues do not cover these costs. Using debt financing this way saves your business’ revenue for issues that may arise over time.
Any loans you incur will come with added interest as you repay your loan, but this cost is often worth it over the course of time. You can think of your loan’s interest payments as insurance against any future losses. If you garner debt now, you will still have cash for when you need it.
You should know that this doesn’t mean you should take out loans for every little thing. If you acquire too much debt and default on your loan, it can have dire consequences for your business and leave you needing to repair your credit.
An Example
Let’s say a restaurant owner relies on debt financing instead of cash. She wants to expand her kitchen and buy a brand new oven. Even though she has the money to pay for the renovation and new equipment, she chooses to apply for a loan.
Then when disaster strikes and she needs to repair her delivery van quickly, she has enough money in the bank to pay for the mechanic. If the restaurant owner had decided to pay for her kitchen renovation with cash, she would have been left high and dry when her van broke down. She would have to turn down delivery orders, costing her money and customers.
Key Takeaways
Most likely, you won’t want to fund all of your business in just one type of financing, so keep these things in mind as you think about your business’ finances:
- Use equity financing for your everyday expenses.
- Use debt financing for long-term costs.
- Only take on a loan if you believe you can eventually pay off the principal and its interest.
If you think debt financing is right for your Marion County business, the Build Fund, operated by King Park, may be able to connect you to flexible, affordable, and responsible funding options for your business. Start the process now!
