Debt financing is when you borrow money that is paid back with interest (a loan). This is provided by external lenders in the form of financial institutions, retailers, suppliers, lending specialists, etc.
Advantages:
- Business owners don’t have to give up control of their business
- Interest paid is tax deductible
- Once the loan has been paid back and finalised, the relationship with the lender ends
Disadvantages:
- The business needs to have a good credit rating to receive financing
- You must the repay the lender even if the business goes into bankruptcy
- Most lenders may require the business owner to guarantee the loan with a personal asset
- Be aware of high rates (predatory lenders)
Equity financing is when you sell a portion of the equity in the company in return for capital (an investor). Sources can come from self-funding, private investors, private equity, etc.
Advantages:
- No obligation to repay the money acquired through equity financing (less burden)
- Less risk as you don’t have a fixed monthly repayment to make.
- You can form informal partnerships with knowledgeable and experienced people.
- If your business lacks creditworthiness, equity financing may be more suitable that debt financing.
Disadvantages:
- You will have to give up a portion of control of your company
- The sharing of control may lead to potential conflicts during e.g., managing your business.