Small Business Financing: Debt Or Equity?

Australian entrepreneurs, on average, should expect to invest between $3,000 and $5,000 in launching a small business. However, according to The Reserve Bank, some small businesses spend up to $10,000, with two-thirds coming from their personal funds depending on the business structure and sector. To cover for the remaining third, owners generally have two options: debt or equity finance.

“Between debt or equity finance, which one you choose will be determined by various criteria, including your industry, the objective of the funding, and the level of influence you want to keep over your business. Understanding which might be a better match so you can kickstart your business or take it to the next level of development is a brilliant start,” advised Shane Perry, a specialist from startup investing firm Max Funding.

When Is It Better To Use Debt Or Equity Financing?

The most advantageous funding for your business is one that meets your business’s current and future financial demands.

Go for debt financing if:

1. You Are Eligible 

Obtaining a business loan is not always straightforward, particularly for a startup in need of capital. Lenders often want a particular amount of years in business, good credit, stable financials, and some collateral. If you fulfill such requirements, you may be eligible for a reasonable interest rate.

2. You Foresee A Favourable Return On Your Investment

For instance, if you borrow $200,000 at an interest rate of 8% and expect a 15% return, debt financing could very well be worthwhile. Another advantage is that paying off debt helps improve your business’s credit score, contributing to increased loanable amounts and lower interest rates in the future.

3. You’re Not Afraid Of Taking A Risk

If you put anything up as collateral, not repaying the loan might result in the loss of the assets. It doesn’t matter whether the debt is unsecured; your creditworthiness will be affected, and valuable assets such as your house or vehicle may be at stake if the lender demands a personal guarantee on the loan.

4. You Want To Get The Most Out Of Your Money

The Long-term financial advantages of debt financing may outweigh those of equity financing. Through equity financing, creditors will be entitled to earnings, and if the business is sold, they will get a portion of the revenues. The amount of income you could make if you owned the business entirely is reduced due to this.

Go for equity financing if:

1. You’d Want To Stay Out Of Debt As Much As Possible

No obligation to repay and no security make equity financing less riskier than debt financing. Moreover, a loan also necessitates recurring repayments, which may threaten the stability of your business’s cash flow and capability to expand.

2. Your Business Isn’t Profitable Yet

You may need equity finance if you can’t get startup business financing and don’t want to use exorbitant solutions like credit cards. Likewise, guarantee that the investment is reasonable in light of your business’s early stages.

3. You Need A Partner Or A Mentor

Investors may provide working capital to help you grow your business. However, their industry expertise or experience might be just as significant, mainly if they participate actively in the development and success of your business.

4. You’re Fine Relinquishing Some Authority

A shareholder with a significant share is eligible for voting rights and may compel the business to take specific actions, such as appointing new directors. Notwithstanding, you may lose total control of your business if you decide to give up more than 50% of your shareholdings. To reclaim it, you’d almost certainly have to acquire shares – which might become costly.

Still Having Second Thoughts?— Mix And Match

As a business owner, you can make use of loan and equity financing in tandem. In most businesses, you’ll find a mix of the two. Your business needs will determine what and how much of each you will have. You can learn more about the typical debt-to-equity magnitude relation by taking a business master class or consulting your financial adviser.