By Rishi Mehra
There will be a time in business when you need to raise money or get a new round of funding. There can be many ways to infuse cash in a business, but the two most popular ways would be through debt or equity.
Both are very different and it becomes understand which will suit your business. To understand and make the process simpler, let us delve deeper.
What is debt financing?
Debt financing is when you borrow money from a lender and pay it back over a period of time with interest. The most popular method of debt financing is when you take a loan from a bank or NBFC. For millions of businesses across the country, debt financing is a popular way of raising funds. When you raise money through a loan, you are not parting with any shares of your company, which means your ownership remains intact. This makes loans a popular choice among borrowers.
With loans you also have the flexibility to use the money for almost any purpose. It is also worthwhile to note that there are different types of loans that are tailor made to cater to a specific need of your business.
However, there are a few things that every borrower needs to take care. In almost all cases you would be making repayments every month and a default on repayment can prove to be a costly financial mistake. In the case of default your assets can be taken over by the bank and under new legal procedures, bankruptcy procedures can also be initiated. Also, if your credit record is not good, you may find it difficult to raise money through the debt route or even pay a higher rate of interest.
What is equity financing?
Equity financing happens when you sell shares or a stake in your business in lieu of money or capital. This is a popular method of raising funds for startups and angel investors, VCs and PEs are quite active in India.
Equity financing is suitable for companies in the growth stage and even companies with little or no physical assets. Investors in such cases bet on the company's growth and the hope of making a windfall on their investment at a later date. Equity financing is popular because there is no immediate pressure of making repayments for the money raised. This means you do not need to set aside some money out of your profits as repayment and if you are making losses, the stress of monthly repayments does not arise. Even if your business shuts down, you are not liable to repay the money and is considered a loss for the investor.
On the flip side, equity financing comes with strings attached. The person or the people who gave you the money become part owners of your business and they will subsequently have a say in how you run it. With equity financing one has to be very sure about the kind of investors you give a stake.
At the end of the day there are other factors which will play an important role in determining what route you take to raise funds.
Urgency - Equity financing takes time and to close an angel or VC deal, it can take anywhere between 3-6 months. The paperwork, disclosures and legal arrangements are complex, which means it takes time and effort to get financing. On the other hand, borrowing money from a lender like a bank takes fairly less time. In fact, banks, NDFBc and modern day fintech lending platforms take pride in their ability to disburse a loan within days. If you need money urgently, debt financing may be more suitable for you.
Amount needed- If you are, especially, a small business, the amount you can borrow through the debt financing route is limited. Most lenders have a cap on the maximum you can borrow under each product or it will be based on your financial. If you are a services company with few assets, your borrowing capacity can be limited as lenders often ask for collateral as a security. Equity financing on the other hand does not look for collateral and the chances of raising a larger amount are far greater. Angels and VCs can write bigger cheques, so if your monetary need is large, equity financing should be the ideal route for you. However, if you are looking for a smaller sum, debt financing should be your preference.
Network - Sometimes as an entrepreneur, you may be looking at not just the money that you raise, but also mentorship, guidance and making relevant connections. With equity funding you are essentially getting a partner who is rooting for your success. An equity investor can open doors for you, make the necessary connections, help you grow and even mentor you. In debt lending, the lender is primarily interested in getting his principal and interest back and not really invested in growth and success.
(The writer is, CEO, Wishfin.com)
Source : https://economictimes.indiatimes.com/small-biz/money/business-loan-vs-equity-financing-which-is-more-suitable-for-your-business/articleshow/66003538.cms