In the age of startups, every person wants to roll out their brand to become successful. While startups are great to gain financial freedom, it requires hard work, patience, and, most importantly, funds to ensure their success.
If you are struggling with a corporate job, you might want to start your own company and become your boss. You may even want extra funds to get out of the debt. If you are going for a startup because you want to get out of debt, then debt consolidation is right for you rather than a startup.
Nevertheless, there are two ways through which you can fund your startup business. One of them is debt funding, and the other one is equity funding. Both of these approaches have their pros and cons.
Let’s go over their differences, what they offer, and which one you should choose.
The Difference between Debt Funding and Equity Funding
Many startups choose from either one of the strategies to get funds for their business. In the case of equity funding, an individual or a venture capital firm invests in the startup with the motive of making money on its returns.
The firm or the investor has a proportion of income that they get once the startup makes money. The investor invests the money, knowing that there are risks involved. They have a share in the equity of the company. Investors also have a say in running the company and are a part of the board of directors.
On the other hand, debt funding is when you borrow loans from an investor through collateral. The investor lends you the funds, which you have to pay back along with interest. The investor cannot make any interference in the business if they are getting their payments on time.
If you are going for a startup and are in debt, debt consolidation is right for you. Once you get your debt in one place, you can then choose any of the two options for your startup.
Advantages and Disadvantages of Debt Funding and Equity Funding
Both of these strategies have their pros and cons. You need to evaluate and analyze both of them to make the right choice.
- Debt Funding Pros
One of the best things about debt funding is having a clear idea about your repayments. You will have an exact amount that you need to pay for over a certain period. Once you complete all your payments, the business is completely yours.
With easy budget forecasting, you can easily manage your cash flows. Additionally, you don’t have to report to anyone and have complete independence in making decisions. The role of the lender does not allow them to interfere in the business.
Moreover, you have all the profits to yourself. Unlike equity funding, you won’t get a proportion of your profits, and all of it will end up in your pocket.
- Debt Funding Cons
Debt funding comes with its own set of problems. Regardless of whether your business is making money or not, you will have to keep up with the payments from day one.
This can be a problem for startups as they are usually cash-strapped in their initial days. The burden of repayments can drain the resources they can use to increase their foothold on the market.
Moreover, the payments are an additional expense that can disrupt the cash flows. Also, if the interest rate is variable, there is no way to know the precise amount you will incur.
What’s more, entrepreneurs are taking a huge risk as they will find themselves in debt if the business fails. By taking a loan against collateral, they will have to pay back their lenders the amount they owe.
- Equity Funding Pros
Unlike debt funding, equity funding does not need a repayment plan. The investor or the venture capital firm becomes a stakeholder in the company. Therefore, you will not have to return the money that they invest in the startup.
Moreover, there are no payments of interest rates as well. As a result, you can focus on increasing your customer base rather than repaying your debt. Also, you can easily access more funds if the startup is going towards expansion.
- Equity Funding Cons
The one thing that can affect your startups is the disagreement of the stakeholders. There is a possibility of a deadlock between you and your investors over the company.
Furthermore, you will have to consult with your investors before taking up any steps. It can slow down the process, and you might lose crucial time. As a result, it can hamper the success of the company.
Also, profit sharing is a disadvantage that comes with equity funding. A set portion of the profit will instantly go to the investors despite your effort and hard work.
Kinds of Equity Financing and Debt Financing
There are different types of ways through which you can avail equity and debt financing.
For availing equity financing, you can choose from either of the options:
Equity Crowd Funding: You can sell your share of the companies to multiple shareholders through crowd funding forums.
Angel Investors: These are individuals who give you the relevant funds in return for a share in the company
Venture Capitalists: This is an entity that consists of one person or multiple individuals that fund your startup. The aim is to get hold of the company or buy a large portion of its shares if it goes public in the future.
For availing debt financing, you can choose from either of the options:
SBA Loans: The federal agency SBA (Small Business Administration) can provide you the loan as the partner with banks to give you the relevant funds
Bank Loans: You can go to a conventional bank for a loan against collateral
Merchant Cash Advances: This type of debt financing is when you take out a loan from a non-traditional creditor and repay it with a share of your credit and debit card sales.
Which One should you choose for your Startup?
And with that, we now come to the million-dollar question that which option is better for your startup? The answer depends on your business. There are many factors that you need to consider before making a decision.
Nevertheless, you must perform thorough research regarding both of the options. Also, look at the pros and cons of both strategies for your business. By doing so, you will know which one is beneficial for you and you can go with that one.
It is the same case when an individual is choosing between debt consolidation and debt settlement. If you want to round up your debt in one place, then debt consolidation is right for you. If you wish to reduce your debt, then you can go for debt settlement.