At the fork of debt & equity finance, which path should you choose?
It’s virtually impossible to avoid injecting at least some capital into a business during the course of its lifespan. Each and every business has a cycle, an upcycle and a down cycle.
The start-up capital investment stage
Before a business lifts its feet off the ground, an initial investment is vital when hoping for and gearing towards the potential growth phase. These capital or business start-up investments are typically made by the stakeholders.
Expansion & growth stage
Next up is the anticipated growth phase! Everyone is in business for this particularly anxious yet highly rewarding time. Just when you thought you had no nails on your fingers left to chew, the intensity of the unknown creeps in and gets you into a cold sweat! But it’s the good kind.
As this phase starts to develop into something that you have always dreamed of and on paper forecasted, you might consider a second capital injection to achieve continued growth. What this invariably does is avoid a growth plateau.
So how much should you invest in your business?
Well, that depends on the stage of your business and where it’s currently at. The initial investment might be a major one with all the outlay costs as well as equipment and building expenses, depending on where the business is situated. The second one can, therefore, be substantially smaller if all you require is an upgrade to machinery or cash flow to employ more staff.
Remember that just because you can’t afford to inject capital into the business from your own wallet, doesn’t mean that the potential of the business should suffer. An external investor might be required to push the business along and ensure that it reaches its potential.
What external source can you rely on for this? That is where the debt or equity capital comes in. To go about implementing what’s needed for this phase, it’s crucial to understand the differences between the two sources and successfully identify the correct business loan option for you.
Opting to take the debt route
This form of financing has a great advantage when considering the time it takes to obtain the finance. It’s the quicker route of the two in question and the process is just as easy as it is fast.
The only negative point that we can really throw-in, is that it does come packed with its added interest and repayment terms that might leave you feeling a little off balance and grabbing for the nearest handrail.
With all these added costs and headache inflicting rates, the total amount when choosing the debt path of the fork will impact your cash flow in a not so favourable way. No one likes a headache and certainly not a lack of cash flow, so please take these things into consideration when scrutinising this form of finance.
Another thing to factor in is that due to the lack of charge in shareholding, any returns that might mature during the growth phase after the debt has been settled, will not be watered down whatsoever.
Let’s for a second assume that your cash flow isn’t an issue. In this instance, the interest expense that you incur with the loan can be used in such a way that it actually reduces the tax the company will owe to the receiver!
Taking a look at equity finance
Equity financing, it all sounds so formal and expensive. But is it? What is it exactly? Quite simply, this form of financing is where the capital injection is received in exchange for a piece of the pie as a shareholder in the business. It’s also a viable way to unlock potential value.
Where taking on debt can assist in the short term, it’s not as beneficial for the long-term growth and benefits that equity financing can offer. Sourcing the most ideal equity partner is fundamental to achieving the businesses’ long-term success goals.
So, what’s the catch with equity financing?
There is always a downside for every upside, and this is no exception. Equity finance dilutes the initial returns as a result of the new shareholder being entitled to their portion of the earnings.
However, if you can choose the perfect partner and advisor for your business, the long-term returns will majorly outweigh the initial dilution that is incurred.
Making sure to partner with the right people for your business is the most surefire way of ensuring that your start-up or growth funding reaches a positive outcome. As discussed, the growth phase is delicate and needs to be treated with the best care to reap the most fruitful rewards for your business!
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