You have paying customers, maybe even a few enterprises. You have revenue. You hopefully have an accounting function. This infrastructure makes debt easy to account for: you know your repayment obligations ahead of time and you can plan for them. In addition, debt financing may offer its own hidden benefits.
Here are five reasons not to be skittish about financing your company with debt. Entrepreneurs tend to think of VC as free money. In fact, if you plan to scale and exit, debt is almost always the cheaper option.
The funding process you go for today will go a long way in determining what it is you can do with your enterprise. It is therefore imperative that you be mindful of your funding options especially during the early days of your business. You need to picture where you want to see your company in the next ten years. You also need to ask yourself how much control you are willing to relinquish in a bid to grow your company.
In summary, debt financing beats equity on several grounds as has been explained here. It is however important that you think deep and hard before making your decision.
Save my name, email, and website in this browser for the next time I comment. Share This! Why is debt cheaper than equity? Some of the unique benefits of debt financing include the following: 1. Unique tax benefits In a case where your company is faced with financial issues, debt financing gives you what equity financing will not be able to.
Debt is cheaper than equity in the long run Several entrepreneurs have the erroneous belief that venture capital is free money. Autonomy in running your business More often than not, a lender will not come to tell you how you should run your organization.
Extra push For companies that are at their early stage of development with recurrent streams of revenue, a minor debt amount will lead to an increase in net cash flow. Luxury of time One of the major drawbacks of equity financing is that it usually takes a lot of time for the funds to be raised. What Is Debt Financing? Conclusion The funding process you go for today will go a long way in determining what it is you can do with your enterprise.
You may also like. A Guide. Add Comment. Click here to post a comment. What Is Federal Bureaucracy? Where Does Tariff Money Go? Comment Share This! Popular Posts. What is Venture Debt Financing? A Guide for Tech Businesses Part 1. Part 3. How Does Venture Debt Work? A Guide for Tech Businesses Part 4. Start the conversation and fuel your business with non-dilutive private debt capital.
Skip to content Venture Debt Guide Apr 02 Equity financing may range from a few thousand dollars raised by an entrepreneur from a private investor to an initial public offering IPO on a stock exchange running into the billions.
If a company fails to generate enough cash, the fixed-cost nature of debt can prove too burdensome. This basic idea represents the risk associated with debt financing. Provided a company is expected to perform well, you can usually obtain debt financing at a lower effective cost.
Conversely, had you used equity financing, you would have zero debt and as a result, no interest expense , but would keep only 75 percent of your profit the other 25 percent being owned by your neighbor.
From this example, you can see how it is less expensive for you, as the original shareholder of your company, to issue debt as opposed to equity. Taxes make the situation even better if you had debt since interest expense is deducted from earnings before income taxes are levied, thus acting as a tax shield although we have ignored taxes in this example for the sake of simplicity.
Of course, the advantage of the fixed-interest nature of debt can also be a disadvantage. It presents a fixed expense, thus increasing a company's risk.
However, if a company fails to generate enough cash, the fixed-cost nature of debt can prove too burdensome. Companies are never totally certain what their earnings will amount to in the future although they can make reasonable estimates.
The more uncertain their future earnings, the more risk is presented. As a result, companies in very stable industries with consistent cash flows generally make heavier use of debt than companies in risky industries or companies who are very small and just beginning operations.
New businesses with high uncertainty may have a difficult time obtaining debt financing and often finance their operations largely through equity. Corporate Finance. How To Start A Business.
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