So you have a great business idea and you’re ready to move forward with it, but how do you secure the necessary capital to build your dream? There are a number of options available, which will be discussed in brief and additional insights will be left up to the financial pros in the “Resources” section.
Debt vs. Equity Financing
What’s the difference between debt and equity financing?
How do I know which to use?
What makes sense for my business?
Debt and equity financing are the two methods of obtaining capital to start and grow a business. There are pros and cons to each, and it is recommended that for a business to be financially healthy, it should secure a mix of both options.
Here is a brief introduction into each source:
Debt financing simply means borrowing money (a loan from a bank or through government grants, for example) and must be repaid over time with interest. There may be a higher level of risk associated with debt financing because start-ups may not have reliable cash flow in the beginning to consistently pay back the loan. Debt financing is beneficial to businesses because the interest paid on loans is typically tax-deductible. Additionally, the lender does not have ownership in the company, allowing for greater profits realized for the owners if the business is successful.
Equity financing means receiving funding in exchange for partial ownership in the business (from venture capitalists, “angel” investors, stock exchange, or friends and family). The loan does not have to be repaid overtime, however, the profits realized by a successful company will be dispersed amongst the owners, decreasing the amount of profit realized by the original business start-up owner(s). This is how investors recoup their costs. Therefore, equity financing can be more costly than debt financing in the long term. Depending on the share of ownership, the founder may also feel a loss of control over key decisions in the organization, which can be a difficult notion for an entrepreneur. As an upside, equity financing may increase the credibility of a new start-up venture, depending on the investor associated. Knowledge and expertise of the investor can also be drawn upon to better the business.
Although there is no one-size-fits-all answer for business financing solutions, experts suggest that businesses find a balance between debt and equity options, as well as varied sources of this funding. This is referred to as the debt-to-equity ratio and a ratio between 1:1 – 1:2 is considered a reasonable ratio for a business. Analysts use this ratio to determine how well a business is run.
How to Get the Financing for Your New Small Business: Innovative Solutions from the Experts Who Do It Every Day (Paperback) by Sharon Fullen $39.95
This resource is a ideal for anyone looking to learn the basics about small business financing. It is an excellent place to start because it breaks down essential information; including how and why to use debt and equity financing, creative financing methods, your loan proposal, links to additional resources and more.
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Canada Business: Government Services for Entrepreneurs
The Government of Canada’s website for entrepreneurs has lots of information about running an entrepreneurial effort, including how to finance your business, and descriptions of the available government grants and loan. There is a short questionnaire on the homepage to narrow down the grants available to your business. This questionnaire asks about the purpose of the financing, business location, targeted demographic and type of business. Depending on your answers, it will provide more information about the government loans and grants for which your business may be eligible.
AVC: Musings of a VC in NYC
Created by Fred Wilson, venture capitalist for 25 years, this blog provides a unique perspective into the mind of a venture capitalist. Where is he spending his money? What companies and businesses stand out amongst the crowd? Wilson also blogs about financing options for small businesses, as well as other funding resources he finds useful. This is a rare insight into the mind of someone who could make or break your business finances.
Whether it’s a large or small figure, every business needs some amount of capital for start-up. Perhaps it’s a bank, a family member or a venture capitalist that fronts the cash, but now it’s in your hands to make it work.