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A comparison of two basic types of small business financing

Small businesses often require money, especially for those at the early stages of development. Getting that money can be an uphill task, since venture capitalists are operating in an environment in which lending is becoming more and more difficult. This is because they are still recovering from a recessionary fallout, together with tighter lending criteria. There are two main types of financing for a small business: equity financing and debt financing. It is up to a small business owner to decide which suits him or her most. Your accountants can be a great source of information and advice.

Debt financing

Debt financing involves a small business owner applying for a business loan from a financial institution, or receiving a personal loan from relatives, friends or other lenders, all which may be refundable.

There are numerous benefits associated with debt financing, one of them being that the lender has no control whatsoever over the small business. The owners relationship with the financier ends immediately the loan is repaid. Another benefit is that the interest that one pays is tax deductible. In addition, since loan payments are generally fixed, it becomes easier for the small business owner to forecast expenses.

On the other hand, debt financing has some disadvantages that are very real to anyone with debts. Debt happens to be a gamble on the small business owners future ability to repay the loan. There is no doubt what would happen if the company experiences hard times, or there is a meltdown in the economy once gain. Supposing the company does not grow as fast as the owner had expected it to do? Debt is an expense that one has to incur on a regular basis and may damper a company's ability to achieve growth.

Equity financing

Since equity financing has something to do with investors, not many people understand it as well as debt financing. One can offer his company's shares to friends, family members or small sale investors, but in most cases equity financing involves angel investors or venture capitalists. The biggest advantage with equity financing is that the investors take all the risks. Should the company fail, the owner dos not have to refund the loan. Also, since there are no loan repayments, the owner will have more money available. What's more, investors adopt a long-term view since they understand that it takes time for a business to grow.

The demerits of equity financing are quite unpleasant. In order to get the financing, the company owner has to give a certain percentage of the company to the investor. He has to consult with his new partners whenever he wants to make a decision affecting the business,while at the same time sharing the profits with them. The only way to remove such investors is to buy them out, which is likely to cost more than the money the owner got from them.

The bottom line is that the type of financing one chooses will depend on the start up. Those first starting out should consider borrowing loans from friends and relatives. Once the business has grown, the owner can then consider equity financing.