As a small business owner, you should never borrow more money than necessary. Debt can be a constant drain on your company’s cash flow, and unless you have the core capital or can generate the necessary profits, you may face problems when the debt is incurred. As a co-founder of a lending business, I believe that there are many ways that debt can be chosen for equity financing, in which you have to sell a part of your business to an investor to generate funds. Here are ways that debt can help your business more than equity financing.
You keep control
The primary advantage that debt offers over equity is that you don’t have to hand over part of your core business to a different person. Even if you only sell 10% or more of your business, you will give up complete control over your company, and you will never get it back. This can divert your business from its original perspective, or in the worst case, stop its growth. While equity financing doesn’t reduce your cash flow—and it does provide you with a cash injection—the downside risk is something that doesn’t sit well with many businesses.
This can be a short-term liability
While debt financing usually only runs for a few days, equity financing is permanent. As long as you buy out your investors at some point, your part ownership of the company will never go away. That 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 an exchange is really in your company’s best interests.
Debt can generate income
When you borrow money, you can leverage that loan by hiring additional employees, expanding your facility, or producing more inventory. The income you generate from these activities can be used to both pay off debt and generate profits that your company can sustain. But if you have equity partners, you will share some of these profits with them. Additionally, as equity financing is a one-time injection, you have to return to the capital markets if you need additional financing in the future. If you sell the company’s equity to generate funds, you’ll share even more of the profits with your investors.
You can create your own financial history
An injection of venture capital does nothing to build your business credit history. However, a business loan that you pay on time can improve your score significantly. This can lead to lower interest rates on future loans you take out. Your credit rating can continue to build with each loan, a benefit that can literally save you thousands of dollars over time.
The loan can be refinanced
Even if you borrow in a high rate environment, you can potentially refinance that loan at a higher rate in the future. In other words, if rates rise, you take advantage of the current low interest rate you have, but if rates fall, you can switch and take advantage of lower finance costs. Depending on the size of your loan – and the interest rate environment – you could save thousands of dollars a year in your financing costs, which you can put toward additional staffing, product or general corporate needs. . If you instead sell part of your company in the form of equity financing, you will never be able to recover what you lost, or take advantage of the changing economic environment.
What to know before taking out a loan
Before your company takes out a loan, there are a few things you should know:
• What is the total cost 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 borrow?
These questions all basically relate to the math of going into debt. While you think you need to borrow $20,000 to buy new equipment, you need to know if you’ll have the ongoing cash flow to service that loan, and if you’ll need to pay for maintenance, servicing, or even marketing. Like need extra money. . You should also explore the consequences if you can’t make your payments – especially if you’re personally liable.
Debt is not something to be afraid of, but it must be managed. While debt provides funds that can be used for expansion and growth, it also creates an additional liability that must be shouldered, even in bad economic times. Debt-based financing may seem like an easy and obvious choice when a business is booming, but things can change if the economy falls into recession. Declining sales can strain your cash flow, making it harder to service your debt.
To avoid these problems, have an action plan before you take out a loan. Be able to answer all the above questions and talk to a personal loan specialist if needed. Borrow only what you need, leave a buffer in your cash reserves and have an exit strategy in case economic conditions get tough.
The bottom line
Debt and equity financing are two common ways companies raise money, and both have strengths and weaknesses. Equity financing, for example, does not reduce your company’s cash flow. Although it weakens existing owners, it does not require interest payments or principal payments. Not only does this free up capital for reinvestment in the business, it also brings cash flow to corporate coffers.
But if you’re looking to leverage 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. Talking to a personal loan specialist can also help if you are looking for the right financing solution that will best suit 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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