Deciding on which route to take
It is usually the case that founders have a choice on whether to go the debt or equity financing route. That choice often depends upon such things as:
- Which type of funding source is most easily accessible to you?
- What is your current cash flow situation?
- How important is it for you as a founder(s) to maintain control of your company?
Founders will come across the term “debt-to-equity ratio”. This shows how much of a company’s financing is respectively provided by debt and equity.
Examples of how equity financing and debt financing work
While both equity financing and debt financing can give founders the funding required there are stark differences in the potential outcome.
Here are examples of both fundraising routes with upsides and downsides of each:
When a founder opts for equity financing this involves giving up (selling) a portion of their company’s equity in return for needed capital.
As an example, a founder needs to raise funds to grow their business. To do that the founder makes the decision to give up 10% ownership of their company to an investor in return for the agreed amount of funding.
Once that deal is sealed the investor is now the owner of 10% of your business. They also have a say in all of the business decisions made going forward.
The main advantages of equity financing are….
By going this route founders have no obligation to repay the money an investor puts into the company. It stands to reason that the founder wants their company to be successful. They also want to provide all equity investors with good returns on their investments.
But whether this is achieved or not the funds given by an investor do not require any set payments or interest charges. As will be seen in the next section, this is not the case with debt financing.
Founders offer up a percentage of company ownership to investors without any additional financial burden to their company. Because there are no monthly/quarterly payments attached to equity finance it means a startup has more funds available to use to grow their company.
All sounds good? Perhaps, but founders need to be aware that there are….
Downsides to equity financing….
The downside to equity financing can be quite significant. As explained, to gain investor funding a founder is giving away a percentage of their company. Once that is agreed founders must be prepared to share any profits with the equity investor.
Founders also have to understand that there will be a need to consult with their new equity investor partners before making any decisions that will affect the company.
Going the debt financing route means that founders borrow money and need to pay back the amount borrowed plus interest. A loan is the most common form of debt financing.
When going the debt financing route founders need to understand the exact terms of such a loan. This is because debt financing can come with restrictions on company activity that may stop founders from leveraging opportunities that are outside of their core business.
When seeking debt financing, founders should also be aware that all lenders will look favorably at startups that have a relatively low debt-to-equity ratio. That factor will also benefit the startup if additional, future, debt financing is required.
The main advantages of debt financing are….
By opting (and being accepted) for debt financing the lender does not have control of any part of your business. Founders make the business decisions they believe are the correct ones without any outside interference.
Once the full amount of the loan plus interest is paid back your obligation with the lender ends. The agreed interest you pay on the loan is also tax-deductible.
Downsides to debt financing are….
Any founder who has ever had debt of any kind knows that when taking a loan they are taking a gamble on their future ability to pay back said loan.
Founders need to weigh up such things as the company they have formed going through hard times, or the general economy once again going into a recession.
A slower-than-expected return on investment in your company can also hamper your ability to grow the company as intended. This is because you are obligated to pay back the full loan amount over the agreed period and at the interest rate set.
As a founder, you need to carefully check the terms and conditions of any debt financing agreement taken out. This is because the lender may still require that the loan given comes with an understanding that your personal (and/or family’s) financial assets are part of a guarantee to secure such funds.
Is Debt Financing the Best Route to Take When Raising Funds?
As can be seen from the above, there are both pros and cons that founders need to take into consideration when deciding on the best way to raise those much-needed funds.
Smart startup founders do not need to take this decision on their own. They will seek expert advice from a company that is highly versed in the startup world.
WOWS Global is one such company. Our truly experienced team has in-depth knowledge of the startup world. We have created a state-of-the-art digital ecosystem specifically designed to assist, advise, and guide startups through all aspects of successfully growing their business. This includes advice on what type of financing will best suit your startup.
To find out exactly what we can offer and to help you understand which is the most effective way to raise funds for your startup please do not hesitate to contact us for an initial no-obligation discussion on: email@example.com