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Understanding debt vs. equity financing as a business owner

As a small business owner, you understand the financial challenges that come with owning a business. Opening a business is a risky venture, but with careful financial management it can also be very lucrative. One of the most important aspects of fiscal planning for business owners is debt versus equity financing. Many people conflate the two, but they are types of financing with their own advantages and drawbacks.

 

What is equity?

Equity means selling shares in a company to raise money. The people who buy shares in a company are referred to as investors.

What is debt?

Debt is when a business owner borrows money with the intent to repay it later. Debt could involve a loan from a bank, a persona loan or taking out a line of credit.

The advantages and disadvantages

Equity’s biggest advantage is that the owner does not have to repay it. Paying debts in addition to everyday operational costs can put some businesses in the red. Having more equity than debt is appealing to investors, as a high debt-equity ratio can signal that a business is risky.

However, equity also has its drawbacks. Because multiple people own shares of a company, your ownership is diluted. Business owners cannot deduct the interest in their company’s shares from their taxes, as they can with the interest on debts. In addition, selling equity requires regular shareholder meetings and careful state and federal compliance regulations.

Which is better for my company?

Both types of financing have their tradeoffs. As a business owner, you must select the one that is best for your company. Finding investors is more difficult for small companies, but they can shoulder a significant weight of the financial burden. If you prefer to retain full control of your company, then debt financing is your best option. However, you must consider the possibility that your lender may foreclose. Whichever method of financing you choose, wise business, financial and legal planning will be crucial.

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