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Debt Vs Equity Funding

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By Author: Carolyn Clayton
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So you've just sorted all your ideas, hopes, predictions and forecasts out and turned them into your business plan. You're now ready and armed to pursue some business funding. So what business funding is available to you?

There are two main categories that you need to know about when it comes to business funding; Debt Funding and Equity Funding. Both of these finance options have their advantages and disadvantages; making it easier to find the one that fits your business in the best ways.

The term debt funding refers to money that it borrowed and has to be repaid over a period of time, this is normally re-paid with interest. This debt funding can either be short term or long term. In a short term sense the full amount to be repaid is done so within a year. In a long term sense the repayments will go on for over a year. With debt funding your only obligation to your lender is to pay back your loan. However in the case of smaller businesses guarantees will probably be needed; making commercial debt funding almost the same as personal debt funding. Debt funding comes from resources such as banks and traditional lenders. With debt funding you will have to make re-payments monthly, which will include interest.

The term equity funding is the exchange of money for a share of business. This allows you to obtain funds for your business without incurring any debt. Selling equity means taking on investors. Many small businesses raise equity by bringing in investors to make their business succeed and get a return on investment. The two main types of equity funding are business angels and venture capitalists.

The advantages of Debt Funding are:

• Don't have to give up ownership/future profits of your business. Your lender has no control of the running of your business
• Using borrowed money to get your business assets will allow you to keep your business profit in the company meaning you can use this profit to pay a return to owners of the company.
• Interest is tax deductible

The disadvantages of Debt Funding are:

• Too much debt may impair your credit rating
• Use profit to pay back debt means if you have a lot of debt all your profit will be used to repay it, leaving nothing to show for your hard work
• Must have sufficient cash flow in your business in order to repay loans
• The riskier the loan the higher the interest rate
• Debt funding can require collateral to secure your loan, which will be seized if you can't repay your debt.

The advantages of Equity Funding are:

• You do not have to pay back your investors even if your company goes bankrupt
• Business assets do not have to be pledged as collateral to obtain equity
• Businesses with sufficient equity will look better to lenders, investors, etc
• Your business will have more cash available because it will not have to make debt payments

Disadvantages of Equity Funding are:

• You will have to relinquish ownership and a share of your businesses profit to other investors
• Other owners may have different ideas than yours on how businesses should be run
• Payments to investors in C-corporations are not tax deductible

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