Launching a business takes courage. Ensuring its success requires something more – namely, capital. One of the most significant challenges that business owners across the wide spectrum of commerce encounter is determining the best way to obtain the funds needed to sustain growth.
There are, essentially, two primary types of capital: debt and equity.
- Debt capital is borrowed money that must be repaid, plus interest, such as a loan from a bank.
- Equity capital is money raised via the sale of interest (e.g., ownership/stock) in a company to investors.
There are pros and cons to each.
When a business owner accepts debt in exchange for necessary funding, a bank or other financial institution will charge interest. For a small start-up, paying interest over a long period of time may not sound like an appealing option, due to a perceived lack of interest-rate negotiating power or the prospect of interest payments impeding upon its profits, or both. Further, businesses are typically required to provide assets as collateral, which could heighten risk if the owner lacked confidence in his or her ability to make all the required loan payments. Finally, debt capital can be more difficult to acquire than equity capital – for nascent enterprises without a proven track record of trending financials, lenders may balk at providing loans.
On the plus side, unlike equity capital, debt capital does not involve the forfeiture of any ownership in the business – a fact that many business owners find attractive. The business owner can continue to run the operation under their own direction, with no outside influence. Also, interest on the debt can be deducted on the company’s tax return. That interest is a known factor, so its expense can be planned for and, in many cases, offset to some degree.
As mentioned, the downside to equity capital is that it necessitates an owner sharing some percentage of the company’s ownership stake. There is a sacrifice of potential control and flexibility inherent to taking on equity capital.
But there are some obvious advantages to consider, too. Start-ups sometimes struggle to procure debt capital, so they may view equity capital as a feasible alternative. Owners do not need to make interest payments, so the saved cash flow can go to profits and help with further expanding the business. Additionally, new investors can bring fresh ideas and expertise, which could move the company in new, favorable directions.
How to Choose
As a business owner, the option you choose will depend equally upon the unique strengths and overall needs of your company. It is important to educate yourself as much possible, weigh all of your available options, and conduct a thorough analysis before moving forward on any path.
Businesses sometimes benefit from loan programs geared toward establishing and developing enterprises that strengthen the community. For help in determining whether your business might qualify for a commercial loan to establish debt capital, please reach out to me or another of State Bank of Cross Plains’ commercial bankers. We can explain all the options available for your particular situation.