How Debt Can Help Your Business More Than Equity Financing

cofounder/partner at lendjy,

As a small-business owner, you should never borrow more money than you need to. Debt can be a constant drain on your company’s cash flow, and unless you have the principal in reserve or can generate the necessary profits, you may face problems when that debt comes due. As the cofounder of a lending business, I believe there are many ways in which debt can be preferable to equity financing, in which you have to sell part of your business to an investor in order to generate funds. Here are ways debt can help your business more than equity financing.

you control

The primary advantage provided by debt compared to equity is that you will not have to hand over a portion of your actual business to a different person. Even if you sell only 10% or more of your business, you will give up complete control of your company, and you will never get it back. This can distract your business from its original vision, or in the worst case, stunt its growth. While equity financing doesn’t drain your cash flow — and it does provide you with a cash injection — downside risk is something that doesn’t sit well with many businesses.

it can be a short term liability

While debt financing usually only lasts for a few days, equity financing is forever. Unless you buy out your investors at some point, their ownership of a portion of your company will never end. This can be a heavy, lifelong price to pay for a one-time cash injection. Before choosing the equity route, sit down with your tax and financial advisors and see if an exchange is truly in your company’s best interests.

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Loan can generate revenue

When you borrow money, you can take advantage of that loan by hiring additional employees, expanding your facilities, or building more inventory. The revenue you generate from those activities can be used to pay off debt and generate profits that your company can keep. But if you have equity partners, you will have to share some of those profits with them. Also, since equity financing is a one-time injection, you will need to return to the capital markets again if you need additional funding in the future. If you keep selling equity in the company to generate money, you’ll need to share even more of your profits with your investors.

You can create your own financial history

The injection of investment capital does nothing to build your business credit history. However, a business loan that you repay on time can boost your score significantly. This can result in lower interest rates on future loans you take. Your credit rating can continue to build with each loan, a benefit that can save you thousands of dollars over time.

loan can be refinanced

Even if you have to take out a loan in a high-rate environment, you can refinance that loan at higher rates in the future. In other words, if rates are high, you still benefit from the lower interest rate, but if rates fall, you can swap and take advantage of lower financing costs. Depending on the size of your loan—and the interest rate environment—you can potentially save thousands of dollars per year on your financing costs, which you can then invest in additional staffing, products or general corporate needs. Instead if you sell a part of your company in the form of equity financing, you will never be able to recoup what you lost, or benefit from the changing economic environment.

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What you need to know before borrowing

Before your company takes on a loan, there are a few things you should definitely understand:

• What is the total cost of the loan?

• Will it affect your personal credit?

• How long will it take to repay the loan?

• Are there any penalties for paying down or refinancing your loan?

• Exactly how much money do you need to borrow?

All these questions are mainly related to the maths of getting into debt. While you may think you need to borrow $20,000 to buy new equipment, you need to consider whether you will have the ongoing cash flow to repay that loan, and whether you will need to pay for maintenance, servicing or even maintenance. That extra money will be needed for things like marketing. , You should also explore the consequences if you can’t make your payments—especially if you may be personally liable.

Debt is nothing to be afraid of, but it should be managed. While debt provides funds that can be used for expansion and growth, it also creates an additional liability that must be covered even in bad economic times. Debt-based expansion may seem like an easy and obvious option when business is booming, but things can change if the economy hits a recession. Falling sales can reduce your cash flow, making it harder to repay your loan.

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To avoid these problems, make an action plan before taking any loan. Be able to answer all the above questions and if necessary consider talking to a personal loan specialist. Borrow only what you need, leave a buffer in your cash reserves and have an exit strategy in case the economic situation gets tight.

Bottom-line

Debt and equity financing are two common ways that companies raise money, and both have strengths and weaknesses. For example, equity financing does not reduce your company’s cash flow. While it depreciates the existing owners, it does not require any interest payments or principal payments. Not only does this free up capital for reinvestment in the business, but it also brings in an inflow of money into the corporate coffers.

But if you want to take advantage of your financing, retain full control of your company, and have flexibility for the future, borrowing money often makes more sense than selling part of your company. Speaking with a personal loan specialist can also help if you’re looking for a customized financing solution that fits your company’s needs.

The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice related to your specific situation.


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