When you're shopping around for a business loan, you might be confused by the types of business financing that are available to you. Often, these loans are described as either equity financing or debt financing. What do these terms mean? What is the difference between the two? Which financing arrangement will suit your company? Here's a comparison of equity financing and debt financing.
How Equity Financing Works
Equity financing involves allowing outside investors to buy a share in your company, which is referred to as "equity.” When you sell a portion of your company to an investor, you receive a sudden cash infusion just as you would when you receive a traditional loan. In return, the investor gets to own a part of your company and have a voice in making decisions about the business strategy.
How Debt Financing Works
Debt financing, though, is probably what most people think of when they hear about business lending. This financing involves taking on debt by financing a lump sum over a period of time. Generally, this type of financing requires that business owners submit to a credit check or put up collateral in order to secure that they will repay the loan. Debt financing may require monthly payments for several years before the loan is finally paid off.
Choosing the Best Financing Option for Your Business
Which financing option is best for your company? The answer lies in the overall goal you have for your business. For example, if you are uncomfortable with the idea of giving up a portion of your company to an outside investor, then equity financing is probably not for you. However, if you are open to hearing the business ideas of others and are interested in taking on additional capital for a major project, then you might find equity financing to be an attractive way to increase the cash flow of your business.
On the other hand, if you have a good business credit rating, then you may be interested in using debt financing. Generally, if you have a good credit score, you can get a low interest rate on your loan or avoid having to put up collateral - both of which can save you a substantial amount on the overall cost of the loan. But, if you have not been in business long enough to turn a profit, you may be cautious about taking on additional debt that could endanger your business in the long run.
In conclusion, both equity financing and debt financing can be helpful to your company. Once you evaluate your long-term business strategy, you'll be able to decide which lending option will help you reach your goals.