Financial Data
Updated 21 Feb 2020

Will debt or equity financing work for your business’ expansion?

Most entrepreneurs might agree that you ‘need money to make money’, as it’s challenging to grow a business without access to finance. Financing your business expansion through debt or equity are good options to consider if you don’t have capital of your own to invest. 

Karl Kumbier, 20 November 2016  Share  0 comments  Print

All the answers to your unique business lifestage questions

They say, ‘You need money to make money’. Most entrepreneurs will agree – it is nearly impossible to grow a business without access to finance. If you don’t have capital of your own to invest, you will need to rely on either debt or equity financing. Debt financing takes the form of a business or personal loan from a bank or even friends and family. Equity finance refers to selling a share in your business to investors.  

Know the difference when seeking funds

Selling a stake in your business can be a good way to secure financing when it is still in its infancy. If your business has lots of assets, but is still generating poor cash flow, or if it is generating good cash flow, but has few assets to secure a loan with. Traditional debt funders, like banks, are unlikely to become involved in either of these cases.

Related: Financial solutions for growing your business

Equity financing is also a good choice for entrepreneurs who cannot commit to fixed repayment terms, or whom do not want to become personally liable for loans to their business. Equity finance also places less stress on the cash flow of the business because it does not require monthly repayments. It may be the only option if the entrepreneur or the business does not have a good credit history.

An investor who owns a share in your business also shares in the risk. If your business should go under, you would not need to repay the investor. However, if your business is successful you would owe them a share of your profits. 

It’s a tough choice

Business -decision

For entrepreneurs who have dreamed of starting their own company and being their own boss, the idea of giving up a stake in that business to someone else can be difficult - particularly if your investors want some input into how your business is run. But, partners can often provide positive input. Remember, the right equity partner can contribute much more than funding to a growing business. A partner can provide experience, relevant skills and support the business in its plans to expand.

On the other hand, debt financing allows the entrepreneur to retain full control of the business and all decision-making power. A bank loan offers entrepreneurs flexibility in how they spend it. After your loan is approved, you receive the money and can use it for whatever you wish. A personal loan from a family member or friend might have more flexible terms, but banks typically do not criticise personal finance choices, as family members might.

Be aware of pros and cons

Debt financing offers tax advantages, as the amount you pay in interest is tax deductible, thereby effectively reducing the total cost of the loan. It makes budgeting and financial planning easier, because you know exactly how much you need to repay on your loan each month. However,it is important to make sure that the business will be able to service the loan and adhere to all repayment conditions.

This means that debt financing is often more appropriate for businesses that are in the more mature stages of development. To fall in this category, your business should be able present audited financial statements for two financial years. Banks will assess the revenue, profit and cash flow of your business when granting a business loan.

Related: External growth strategies

As an entrepreneur, you should do thorough research before settling on a funding option. Take into account the cost of funding, and flexibility of repayment terms. Find out what the terms and conditions are. Does it provide the option of settling the loan early? Will this carry any penalties? What collateral is required?

Banks may also offer much needed help with financial planning, especially in a tough economic climate. A bank that is familiar with your financial status is able to fulfill the role of a financial advisor. Your bank should understand the complexities of your business and talk you through the fluctuations it experiences in a tough economic environment.

Entrepreneurs should shop around, and get comparative quotes, when looking for financing options. Make sure that you have looked at a wide spectrum of offers from which you can make an informed decision on growing your business.

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About the author

Karl Kumbier

Karl Kumbier is the Chief Executive Officer of Mercantile Bank Limited.

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