Raising capital through debt is often compared to raising capital through equity. The major difference is that equity requires you to give up partial ownership of your company. Debt capital however, allows you to keep all ownership in return for interest and principal payments. As you can imagine, there are many pros and cons to this method of financing.
The major negative with debt capital is that your funding will come from banks or other lenders. These institutions look for low risk investments, something that many start-up businesses can not offer. Linked to that is the obligation to pay monthly interest on your loan which can be very difficult for businesses without established revenue streams.
What do this mean for your business?
Those businesses in the design or startup stage will have a harder time financing through debt because they cannot meet the immediate interest expenses. In other words, if you have no income because your product or service isn’t finished yet, it is less likely for you to be funded by a bank.
Most banks will ask for your old financial statements, more specifically for documents from the last three years. These documents allow the bank to evaluate how risky your business is and if you’ll be able to make the monthly payments. Depending on your business’ current position, this will either help ensure you a loan if you have healthy revenue streams, or make funding through debt more difficult.
However, there are several positives in financing through debt capital.
Most entrepreneurs have trouble with giving up partial ownership of their company, as is the case with equity financing. They do not want the influence of others in their firm, and would rather put their own vision forward in order to grow the business. Thus, many entrepreneurs seek debt financing over equity financing.
With a traditional loan, you can continue to run your company as you see fit. Venture capital requires you to meet an ‘exit’, or a return on investment for the venture capitalist that usually occurs in some form of acquisition of your company. This won’t be the case with debt capital, as there is no pressure from banks to meet a long term exit strategy.
Since you have not given up partial ownership in your company, you also don’t have to share the proceeds with investors should your company be acquired further down the road.
Moreover, many entrepreneurs underestimate the amount of work it takes to receive equity funding. Thorough business plans and presentations are just part of the work associated with venture capital. You also have to network extensively in order to find the right investor, and potentially re-work your idea multiple times until you have the smallest of chances to be funded. Financing with debt instead of equity will potentially save you valuable time and energy.
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