Cofounder / Partner of Lendzi.
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As a small business owner, you should never borrow more money than you need. Debt can be a constant drain on your company’s cash flow, and unless you reserve the principal or generate the necessary profits, you may face problems when the debt comes due. As a cofounder of a lending business, I believe that there are many ways that debt can be better than equity financing, where you have to sell part of your business to an investor to generate funds. Here are ways that debt can help your business more than equity financing can.
You Remain in Control
The main advantage that debt offers over equity is that you don’t have to hand over a part of your actual business to a different person. Even if you sell 10% or more of your business, you will give up complete control of your company, and you will likely never get it back. This can divert your business from its original vision, or in a worst case scenario, prevent its growth. While equity financing doesn’t drain your cash flow—and it does give you a cash injection—the downside risk is something that many businesses don’t like.
It Can Be A Short Term Obligation
While debt financing usually only runs for a few days, equity financing lasts forever. Unless you buy out your investors at some point, their ownership of a share of your company is never lost. This can be a huge, lifetime price to pay for a one-time cash injection. Before you choose to go the equity route, sit down with your tax and financial advisors and see if the exchange is really in the best interest of your company.
Debt Generates Income
When you borrow money, you can use that loan by hiring more workers, expanding your facilities or building more inventory. The income you get from these activities can be used to pay off debt and generate profits that your company can sustain. But if you have equity partners, you have to share some of the profits with them. In addition, since equity financing is a one-time injection, you will have to return to the capital markets again if you need additional funds in the future. If you continue to sell equity in the company to generate funding, you will need to share more of your profits with your investors.
You Can Build Your Financial History
An injection of investment capital does nothing to build your business credit history. However, a business loan that you repay on time can increase your score. This can lead to lower interest rates on future loans you may take out. 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 at a high rate around, you may be able to refinance that loan at a higher rate in the future. In other words, when rates are higher, you benefit from the current low interest rate you have, but when rates fall, you can trade up and take advantage of lower financing costs. Depending on the size of your loan—and the interest rate environment—you could save thousands of dollars per year on your financing costs, which you can deploy to additional staff, products or general corporate needs. . If you sell a part of your company in the form of equity financing, you will not be able to recover what you lost, or benefit from the changing economic environment.
What You Need to Know Before You Borrow
Before your company takes out a loan, there are a few things you should make sure you understand:
• What is the total amount of the loan?
• Will it affect your personal credit?
• How long will it take to pay off the loan?
• Are there any penalties for paying off or refinancing your loan?
• How much money do you need to owe?
All these questions are mainly about the math of the loan. While you think you need to borrow $20,000 to buy new equipment, you need to understand if you have ongoing cash flow to service that loan, and if you need more money for things like maintenance, servicing or even marketing. . You should also consider the consequences if you can’t make your payments—especially if you can be held personally liable.
Debt is not something to be afraid of, but it should be managed. While debt provides funds that can be used for expansion and growth, it also creates additional responsibility that must be taken care of, even in poor economic times. Debt-based expansion may seem like an easy and obvious option when business is booming, but things can change when the economy is down. Falling sales can strain your cash flow, making it harder to service your debt.
To avoid these problems, have a plan of action before you go into debt. Answer all of the above questions and consider talking to a personal loan specialist if necessary. Borrow only what you need, leave a buffer in your cash reserves and have an exit strategy if economic conditions tighten.
The Bottom Line
Debt and equity financing are two common ways that companies raise money, and both have strengths and weaknesses. Equity financing, for example, does not drain your company’s cash flow. Although it dilutes the owners, it does not require any interest payments or principal payments. This not only frees up capital for business reinvestment, it also brings an influx of money into corporate coffers.
But if you’re looking to leverage your financing, maintain full control of your company and have flexibility for the future, borrowing money often makes more sense than selling part of your company. Talking to a personal loan specialist can also be helpful if you are looking for a tailored financing solution that best fits your company’s needs.
The information provided here is not investment, tax, or financial advice. You should consult a licensed professional for advice regarding your specific situation.
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