Debt vs Equity
Which is better financing for start-ups? Debt or Equity financing?
Debt financing is cheaper than equity financing, but it has its own set of disadvantages. It takes longer time to raise money from banks and other financial institutions. Banks are not keen on lending money to small businesses because they fear that if the business fails, they will be held responsible for the loan. The interest rates charged by banks are higher than those charged by venture capitalists. However, there is no doubt that banks can provide more flexible terms compared to venture capital firms.
On the other hand, venture capitalists have their own set of advantages. They usually charge lower fees than banks. In addition, they do not require collateral security. Venture capitalists also offer a wider range of services such as legal advice, tax planning, accounting and marketing support.
The choice between debt and equity financing depends on many factors including:
- The size of the company
- Its growth potential
- The amount of risk involved
- The availability of alternative sources of finance
- The cost of borrowing
- The expected return on investment
If you decide to go for equity financing, then you should prepare yourself well before approaching investors. You may want to develop your network with people who can help you find investors. This includes bankers, lawyers, accountants, consultants and even friends and relatives.
If you decide to go for debt financing, you should make sure that your business plan is ready. Your business plan should include information about the market, your products and services, your target customers, your competitors, your management team, your financial projections and how much funding you need. You should also know what kind of loans you can get and at what rate of interest. For example, you can borrow from banks at low interest rates but you cannot borrow from them without providing collateral security. On the other hand, you can get loans from venture capitalists without any collateral security. But you must pay high interest rates.
You should also ensure that your business plan is attractive enough to attract investors. Investors like to see companies that have been around for some time and have achieved success. They also prefer companies that have already established themselves in the industry.
In conclusion, if you are looking for cheap financing, you can always opt for debt financing. If you are looking for flexibility and access to a wide range of services, then you should choose equity financing.
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Thanks for your educative post. Ironically the almost only option for small business is self raised funds from your oneself and family. Debt and equity has proven to be a hard nut for SMEs.
ReplyDeleteYour stance on this is apt..this is due to the fact that investors and financiers would rather associate with existing businesses with good past performance and future prospects (after due consideration of some other indicators) than startups greatly faced with uncertainties. We hope to shed more light in future articles.
DeleteA concise piece on debt financing. Kudos! But it would be great if you in subsequent treatise emphasize in details on the concept of social quotient and how it enhances access to equity financing. The concept of information assymetry, moral hazards and adverse selection as a bane to access to capital for start ups. It might be good to make those insights handy and punchy for those primming to join new business ventures without cognate experience.
ReplyDeleteThanks for your insightful comment. Do follow us for future articles as we hope to address all captured in your feedback.
DeleteGenerally, taking on debt financing seems usually a better move than giving away equity in your business. Unfortunately newbies and low scale entrepreneurs scarcely enjoy that privilege as in most cases they end up turning to family and friends for support or worse still get frustrated into killing the business dreams.
ReplyDeleteLearnt a lot from this post, looking forward to more posts here. Hoping there will be a post soon on the best source of funds for start ups. Thank you.
ReplyDeleteVery good info. I commend for the program and the vision of your consult. But the problem I have with the Consult is that it didn't make provision to those small business groups like the vegetable sellers, hockers, barbing salon operators etc. For this group to start their business it's always a problem because it's either they get their initial capital from their friends or relations no place for them from any established financial companies. My advice is that these group should also be considered by your consult because they are part of the Economy. Gbu!
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