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Funding your Business with Loans vs. Equity Capital

Running a business takes money, and unfortunately in all businesses there are times when you might come up a little short, and need some funding or financing. There are two basic ways of funding or financing a business: debt and equity.

Let's take a closer look at these two options:
Basic Definitions:
Debt financing:
When you get a loan, that means you incur debt. Loans are debt financing; you borrow money and must pay it back, with interest, within a certain timeframe. This is one option for funding your business.

Equity financing:
We all know what it means to have equity in your home, but what does this have to do with business. Well, you can have equity in a business as well. With equity funding or financing, you raise money to keep your business moving forward by selling a portion of your ownership in the company.

What this means, pros and cons:
Debt financing:
When you choose the route of debt financing you must find a financer to give you a loan. Common debt financers include banks, finance companies, credit unions, credit card companies, and private corporations.
So, what are the pros of choosing debt financing?
- Well, getting a business loan allows you to maintain control. You remain in the driver's seat of your own company and do not have to answer to investors because they have no ownership.
- Another pro is that you can usually get this type of funding faster, as searching out investors can be a long tiresome process.
- Another benefit of debt financing is that as you pay down your loan you build creditworthiness, and thus you increase your chances of getting future loans if necessary. Not to mention you increase your chances for better loan terms on any future loans.
- Debt financing is typically cheaper than equity financing because you owe only principal, interest, and fees, and retain your full ownership stake in your company.

Cons of debt financing include:
- If your company fails you still have a debt you have to pay, and nothing to show for it.
- You have monthly payments to make, and initially you may not be bringing in enough money to pay those.
- If you have poor credit, it is nearly impossible to go this route.


Equity Financing:
When you choose the route of equity financing you must find a financer willing to invest in your company. Common equity financers are investors, or venture capitalists; the type of investor will depend entirely on the type of business, though for small business it is common to see relatives, friends, and colleagues, or even sometimes customers as the investor. Selling equity in your company means taking on investors and being accountable to them for how well, or poor, the company does.
So, what are the pros of choosing equity financing?
- You do not have to have good credit worthiness or try to secure a loan.
- You do not have to pay the person back, per say.
- You do not have monthly payments to a creditor.
- Often you can get more substantial amounts of money invested in your company than you would get with a loan, or debt financing.

Cons of equity financing include:
- It takes a long time to secure such financing, professional investors review thousands of investment opportunities each year, and only invest in a small fraction.
- Depending on how passive or active of an investor you have, you may run into problems such as personality conflicts, which can arise in either arrangement.
- Equity financing is not cheap: your investors are entitled to a share of your business's profits indefinitely, so it is not like you pay them back what they put in plus a little interest, often it is much, much more.

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