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Finance is the basic requirement for starting or expanding any small business. Those who do not have big savings to start it on their own need somebody to help achieve their aspirations. Small entrepreneurs have plenty of sources to get funds for starting their business.
Debt and equity financing are two financial strategies that can help you get going. Incurring debt entails you to borrow money for the business. By gaining equity you can put stakeholder’s cash in to your business or pump in your own money.
Debt financing:
Many small business owners have the misconception that borrowing from financial institutions depletes their cash profits. In reality it is a good option if you have sound cash flows to repay loan with interest amount.
Advantages:
1 The ownership of the business remains with you. You continue to enjoy sole right on profits generated by your business. You also remain the sole controller of your business and the lender has no right to interfere.
2 You can retain entire profits with the company or use it for repayment of the loan.
3 You get entitled to tax exemptions on the amount of interest paid to the lender.
Disadvantages:
1 You are required to maintain sufficient cash flow to repay loan, or part with cash profits to pay back.
2 The lender may charge higher interest if it treats your application for loan as high risk value.
3 Lender gets rights to seize your collateral, in case of non repayment.
4 Large and frequent debts can lower your credit rating and hamper future prospects of raising money.
Equity Financing:
Equity financing is the preferred option for most of the small business owners who find it difficult to qualify for loan and refrain parting with cash profits to repay loan. Equity financing can be availed either from partners in the business or the investors. Just like debt financing, equity financing also has its own set of advantages and disadvantages
Advantages:
1 Equity contributions are not required to be paid back even in the situation of bankruptcy.
2 You do not have to pledge business assets as collateral to avail equity investments.
3 Sufficient equity enhances credibility with lenders and investors.
4 More cash is available for use since no debt payments have to be made.
Disadvantages:
1 You are required to share profits with equity investors and surrender some of your ownership stakes.
2 The investor will have a say in running of the business.
3 Dividend payments are not tax exempted.