Business entrepreneurs are always on the look out for funds to either start-up a new venture or materialise the expansion plans they have been harbouring for quite some time. Accumulation of funds is definitely a tricky business. Apart from being able to lay you hands on as much as you can possibly gather, fund raising has a lot to do with managing and developing investor relations. Investors are the key to any business success and the way you deal with them is of utmost importance.
There are majorly two ways in which you can attempt to create a healthy capital structure for your business enterprise. These are debt financing and equity financing. Your choice depends largely on your preferences. There are entrepreneurs who love to manage their business houses independently and are always looking to deal with their financial liabilities within a short span of time. Debt financing is an ideal option for them. There are others however, who prefer to include investors in the decision making process. They are inclined to exploit the technical knowhow and business acumen of expert investors, for improved profitability and comprehensive success. Equity financing is suitable for such entrepreneurs.
However, according to financial analysts, making an exclusive choice is improbable. The capital structure of a healthy organization must be generated from a combination of debt financing and equity financing. The choice and the proportions allotted to each depend on the long term goals the entrepreneur has set for his business venture. Business experts suggest that a company should have a commercially accepted ratio between their equity and debt financing options. The ratio is an indicator for professional management of an organization and is often used by investors to select the right investment option. Ideally the debt-equity ratio should be between 1:1 and 1:2. This is a general thumb rule which applies to organizations across various segments.
According to some analysts, business start-ups should avoid debt financing options during their inception stage. Instead, they should opt for equity financing sources. When a venture starts off, the cash flow is limited and the entrepreneur might not be in a position to settle debt financing loan instalments in time, attracting heavy penalties. Equities will ease the cash crunch, and the start-up can look at a state of solvency in a few years time, which is when it can consider debt financing options. However, without strong capital base and profit potential, attracting venture capitalists for equity funding could prove to be a Herculean task. In order to set up a strong capital structure, any start-up would definitely need some assistance from debt financing. Therefore, one cannot follow a fixed pattern. The business entrepreneur has to keep the goals and present requirements of the organization in perspective, and create the right balance.
As an entrepreneur, you need to weigh the pros and cons of debt financing options, before you can actually offer them to your investors. Debt financing is actually a loan, which can be provided by your bank, a relative, your credit card, or any other organization. Debt financing loans need to be paid back with interest, within a stipulated period of time. One can either tap personal resources for landing a debt financing option like friends, associates, family etc; or can even apply for a bank loan. If you can avail of your own resources, you will be able to reap the advantages of low interest rates. Bank Loans are great debt financing options, but the interest rates could be high at times.
The major advantage of providing debt financing options to investors or commercial institutions is that as a business entrepreneur you can enjoy the complete liberty to control your business processes without any undue interference. You take your own decisions and can be the sole recipient for all the ensuing profits. You will be singularly accountable for your successes as well as failures.
Thus, debt financing options offer you the true freedom of being a business owner. Besides, when you opt for a debt financing loan, the interest payable is tax deductible. In this way you are able to reduce substantial cash liabilities, which is sure to have a positive impact on your business proceedings. In return, you just need to payback your loan on time. Lenders do not have a share in profits. There are specific organizations which provide debt financing options in the form of specific loans. For example, there are small business organizations which grant loans on really low rates of interest to small start-ups. Options such as these could really prove to be lucrative debt financing options for new ventures.
There are disadvantages associated with debt financing, too. The biggest is perhaps the payback schedule, which could be pretty demanding at times. Irrespective of what your current business requirements are, you need to pay up the instalments on time. Being a defaulter could ruin your credit history and affect your credit scores adversely. Sometimes banks might ask you to pledge your personal assets or valuables for availing of a loan. Such debt financing deals could be potentially unsafe. If you are unable to payback in time, you stand a chance to lose your personal belongings. Sometimes lenders might tell you to incorporate your business, in order to avoid keeping your personal valuables at stake. The truth is, you might still have to pledge a new business or your personal valuables for availing of debt financing options, even after business incorporation. In worst cases, debt financing could also be a major cause for pushing you towards bankruptcy.
There is no universal answer to whether you should offer debt financing or equity financing options, to potential investors. It depends on a host of factors which include your credit standing, potential investors, long term business oriented goals, business plan and segment, tax liabilities, as well as capital requirements. Keeping all the above factors in perspectives, one can attempt to decide whether they would be offering debt financing options to investors or equities. Both have their specific individual pros and cons. You just need to strike a balance between the two, for maximum benefits.