In every business, it is essential to maintain a continuous flow of money for the business to flourish. There are basically two ways you can capitalize your business. You can borrow money (debt) or share the ownership of your business (equity).
You can equally find investors who are ready to fund your business after you must have agreed to their terms and conditions (equity).
Your choice should be guided by though not limited to
- How much cash you need for your business
- The nature of the business you intend to start
- Your financial stand/situation
Equity refers to all the funds contributed to a business by the owner(s) of the business without any guaranteed return. Unlike debt which must be repaid, equity is simply exchanged for the ownership interest of a business.
Equity financing may come in the form of personal funds, money you receive from wealthy friends, relatives, customers, employees, industry colleagues or from investors who are interested in your type of business (venture capitalist).
All things being equal, you should look for investors who are experienced and understands the nature of your business. You should also look for investors with whom you are compactible to avoid doing business and sharing ownership with someone you dislike. An investor on the other hand looks for high return on investment profit.
Advantages of equity financing
- Equity financing are not usually repaid, it stays in the business as long as the business lasts unless replaced by other equity.
Disadvantage of equity financing
- You may have to surrender some control of your business to investors.
- You have to seek the opinions of the investors before making decisions irrespective of how disagreeable they might be.
Debts are funds loaned to the business by outsiders/ lending institutions for a defined period of time and for some specified purpose. It is usually paid back with some form of interest. You become a debtor and are bound to personally repay if you personally borrow the funds for your business. But if your business borrows from any available financial source, your business becomes the debtor. No matter who the debtor is, always look for a lender who will lend you money at the least possible interest rate.
This depends on the nature and size of your business, the financial needs of your business and the lender’s lending practice. On the other hand, the lender would want to know if you can repay your debts when the time is due and your ability to provide collateral.
The lender will also want to know your credit history, your personal investments in the business (equity), your managerial/ business experience, risk of failure of your business, your current and projected business income as well as your personal income. Debt financing can be sourced from banks, loans, commercial finance companies, credit unions, money lenders etc.
Advantages of debt financing
- Lenders are not co-owners of the business, but creditors which the business needs to pay back the loaned amount on a specified period with interest.
Disadvantages of debt financing
- It is usually difficult to obtain loan from financial institutions especially when you do not have collateral.
- You will likely pay more than you borrowed. The extent to which you do so will depend on the interest rate and interest type (simple or compound interest).
- You may end up losing your business, the assets you used as collateral or made to pay penalty fees if you fail to pay up your debts.
In making decisions for your enterprise, you need to identify and consider the available sources of finance such that your choice will be based on the availability, accessibility, characteristics and the cost of the various sources of fund for your enterprise.
The title of this post is how to capitalize your business