Figuring out how to finance your business is one of the first things that you need to address as a budding entrepreneur. Your great ideas or products will only get you so far, as you’ll need financing in order to proceed with your day-to-day operations. Now, raising capital is easier said than done. This is especially true for small and medium enterprises (SMEs) with limited resources.
For the most part, you’ll have two choices when it comes to SME financing: equity or debt. There are pros and cons to each option. To help you decide, we’ve put together a brief explainer on these two options. Read on as we break down everything you need to know when weighing equity vs debt for SME financing.
Equity financing involves raising capital by selling a stake in the business. Essentially, you’re exchanging portions of ownership to willing investors for funding. This can be appealing for SMEs, especially startups as it provides them with a much-needed cash injection without the expectation to make immediate repayments, a boon for startup businesses that might find difficulty in their early stages.
Beyond capital, equity investors can also bring valuable expertise and industry connections to the table. This can help enhance the management capabilities of the SME and can result in both long-term and short-term benefits. Equity financing can also curb the risk of starting your own business. By sharing ownership, the risk is spread among investors. In case the venture fails, the burden isn’t solely on the business owner.
One thing you need to consider when it comes to equity financing is that it’s a long-term collaborative commitment. Business owners need to be prepared for a collaborative relationship with their investors, as they may bring differing opinions and strategies to the table. The other important thing is the cost of dilution. Investors, especially in this rising interest rate environment can demand for returns upwards of 20% on their investments which could be costly. As such it is important to really weigh the benefits against the cost.
Now, giving up equity in your business may not be an appealing option to some business owners. This is where debt financing comes in. Debt financing, as the name suggests, involves borrowing funds that need to be repaid over a specified period.
Unlike equity financing, debt financing doesn’t require you to give up ownership of your business. The lender does not become a co-owner, meaning all decisions still lie with the business owners. In this setup, the borrower needs only to track the monthly payments they’ll have to make. This also means that managing your cash flow will be a lot easier.
It should also be noted that while having to pay interest rates on the loan may seem troublesome, all business loan interest rates are tax deductible. This can give you a little more wiggle room when it comes to managing your business’ finances. The primary consideration with debt financing is the obligation to repay the borrowed amount, regardless of the business's financial performance. Failing to meet these obligations can lead to severe consequences. Debt financing cost can range from 7-8% p.a. for banks and up to 3% per month for non-banks. Therefore detailed cash flow planning is important.
If your company is in the early stages, there are ways to still get debt financing. One of the ways is through a collaterised loan using property, shares or even unit trusts. This way you are also able to get a larger loan quantum.
For the best results, we recommend conducting a thorough assessment of your business’ needs, growth projections, and risk tolerance. Doing so will help you gain a better understanding of which option is right for you. Consulting with financial advisors could also be beneficial. These professionals can help provide you with tailored advice based on the specific circumstances of your business. They can help ensure that you choose a financing option that is aligned with your goals.
All in all, choosing between equity and debt financing will depend on your specific situation. Businesses looking for an urgent cash injection may be better off debt financing. On the other hand, businesses that want to operate without the pressure of having to pay back the money immediately should consider the equity route.
These are the unique benefits that come with each financing option. The choice between equity and debt financing is a pivotal decision that can shape the overall trajectory of your business. If you want to maintain full control of your business, debt financing might be the way to go. If you’re looking for a quick cash injection without the stress of immediate repayments, then equity financing might be the best option for you.
It’s important to keep in mind that there is no one-size-fits-all approach to financing your business. Be sure to be thorough when assessing your options so that you can arrive at the one that makes the most sense for your business. Lendingpot is the perfect place to find your next business loan. Our platform offers a wide selection of pre-screened lending partners, with over 45 options to choose from. Register today to leverage our lenders for your corporate growth and stability.
Lina heads up all things marketing and branding at Lendingpot. With a keen aesthetic eye, she believes in the use of design to communicate with our SME community and aspires to turn Lendingpot into a household name. Out of work, she is an avid camper and appreciator of nature’s best works.
