Deciding between Debt and Equity Financing

Essentially, there are two types of financing; debt and equity. The use of either method – or both – to finance the business is of critical importance to the business. The nature of financing will strongly determine the company’s very chances of survival, as well as its rate of growth. An explanation of both methods of financing together with their respective advantages and disadvantages are explained below. Keep in mind, however, that your professional advisors should assist you in making the ultimate decision on the best combination of debt and equity.

Debt Financing

With debt financing, you borrow money and have to pay interest for the privilege. If you take on too much debt, it could become cumbersome and you could find yourself at the mercy of the lender if things do not go according to plan and you are unable to service the debt.

There are numerous methods of debt financing from straightforward loans, lines of credit, accounts receivable financing, business improvement loans, leasing and second mortgages to debentures secured by the companys assets and intellectual property. Debentures are often convertible in to equity on various terms and conditions at the option of the lender. Lenders, outside of family and friends – will almost always require security other than the business itself.

The primary advantage of debt financing is that you keep all the ownership of the company in your hands unless the lender has a convertible debenture and elects to to convert its debt in to equity at some time. The disadvantage is that you may lose all of your security if the business fails.

Bank financing is usually only part of your entire financing package. You will need a substantial number of assets of your own to pledge as collateral before the bank will come up with any money. Banks are lenders, not venture capitalists.

There are various government programs available to small business owners who need capital. Among them are federal or provincial government equity plans which provide capital directly (through the Business Development Bank of Canada or provincial government development corporations) or indirectly (through incentive programs for the private sector to fund small businesses). These programs can be an alternative when conventional methods of borrowing are unavailable. Dealing with these programs often requires patience and persistence as most involve a lot of paperwork and the approval process can be lengthy.

Equity Financing

Equity is the money that is put in to the business in exchange for shares. Equity financing means you sell a share of your ownership , which means a reduction in control.