Financing your start-up: equity or loan?
The right start-up financing gives your new business a solid financial base and every chance to succeed. It makes sure you have the funding to cover your short-term needs and to help your opportunities grow. Working out how to finance your start-up begins with knowing how much money you are going to need and where to find it. For entrepreneurs that intend to start up a business, there is plenty at stake, and just getting started can be difficult.
One of the main reasons for this is that initial costs can be higher than expected and sales often take longer to arrive than planned, so funding from external sources is often needed. Selling equity is a very popular way to fund a start-up, as is taking on debt by receiving a loan. Many entrepreneurs are reluctant to give away equity however this is often the right thing to do as new companies rarely have sufficient cashflow to repay loans/debt. One thing that every start-up should avoid is taking on funding to fundamentally prop up an unprofitable or unsustainable business model.
For those who have watched the popular TV show Dragons’ Den, you will undoubtedly be aware of how challenging it can be to be accepted and successfully acquire funding through an angel investor.
To be able to sell equity to investors, start-up business owners must have an effective and realistic business plan which they can pitch with confidence. They must also decide how much of the business’s equity they want to sell, how much funding they need and be realistic over valuation and how and when the investor will get a return.
One of the main advantages of this funding method is that nothing changes in the business except the ownership structure, and you do not have to repay this money, allowing you to invest fully in the plan.
Going to your local high street bank used to be one of the most popular methods of applying for loan finance, but since the financial crisis in the late 2000’s, many banks have shut their doors to what they perceive to be “risky” start-ups. As a result a large number of new funders have emerged in the alternative funding market who can be accessed easily online or through online platforms like Capitalise.
Whilst taking on debt means that the business must make regular, potentially substantial, repayments and interest, it also means that you retain full ownership and are entitled to keep all the profit your business makes.
On the other hand, if the business goes under (50% of businesses fail in the first 2 years), you will still have a debt to pay which may have significant personal implications if you have given a guarantee. This is as opposed to equity funding, where your investors take the financial impact.
Which funding option is the best for financing your start-up?
Each of these methods are suited to different business types. Start-ups can be incredibly changeable, and both investors and lenders will have different levels of risk tolerance. Loans are often the wrong choice for start-ups as they need cash generated to continue to grow and stay alive.
Equity funding may also give you access to greater funding amounts and access to the investor’s experience and a guiding hand. On the other hand, a loan may be simpler and steadier, and ensure the business remains yours in the long run.
Equity is primarily suitable for longer term investment, product development, start-up losses, R&D, proof of concept and capital equipment. Whereas Debt is primarily suitable where there are predictable and known cash flows that can service it and also where there is security available e.g. business & personal assets.
Ultimately, it is down to each individual entrepreneur to choose the right method for their needs/goals. Make sure that you know your business’s facts and figures and its growth potential to maximise your chances of getting the right funding.
Deciding whether to finance your new business venture through loans or by giving shareholders a stake in your company is a serious matter and you should understand your options before making this decision. Speak to one of the EFM Experts to find out how they can help you make the right choice around your start-up’s funding source. Click here to request a call back or call EFM central on 01582 516300 to get in touch today.
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