You might have heard of equity financing, or debt financing, but aren’t sure what it all means. If you’re looking to raise money for your business, then these are the two most known options you have and today we’re going to explain what they are and the pros and cons of each, so you can make the most informed decision possible.

What is Equity Financing?

Equity financing is essentially exchanging incoming capital investment for a share of ownership in your business. Investors will receive a percentage of your profits based on their ownership level, which is agreed upon beforehand. There are a few different methods, including partnerships, angel investment, crowdfunding, venture capital, royalties or an IPO (initial public offering). To do this you need stockholder consent, an investor rights agreement, board consent, a stock purchase agreement and a restated certificate of incorporation.

Pros: This finance method has the potential to bring in much larger investments, which means you can not only fund your launch, but keep the business growing and scale up quickly. It’s typically used by start-ups who want to achieve very rapid growth, and since you don’t have the pressure and stress of debt working against you, you can make more considered decisions for your business. Finally, equity financing shows that third parties have a vested interest in your success, and the confidence that you can achieve it.

Cons: This method means that you are no longer the sole owner of your business, which can impact a lot of decisions you make. Reducing your ownership stake also means you have to split the profits of your business– sometimes paying them before you receive any profits yourself! It can also take a lot of time and effort to achieve, and not every approach will be successful. You need a powerful pitch deck at the very least to start equity financing, and without the right connections, it can take a long time and a lot of effort to find the right investor.

What About Debt Financing?

Debt financing is what it says on the tin – financing your business by borrowing. We’re all familiar with debt, and you can do the same thing for your business, borrowing money and repaying it in monthly instalments over a fixed amount of time. The exact terms of your repayment will depend on whether you’re raising debt from investors, using lines of credit or working capital loans.

Pros: You get to retain control of your business. You get to make all of the decisions, keep all the profits, and once you’ve paid the debt off, your liability is over. Debt financing can also mean you’re eligible for certain tax deductions, which can have a big impact on your net profits as you grow.

Cons: By doing this, you are taking on a hefty monthly bill. Even if you have low net profits, you still have to make a monthly repayment, which can be a huge burden on a start-up. And if you’ve chosen to use your personal credit to fund your business, you may find both your personal and work life are on the line if you can’t make repayments. Too much debt can also have a negative impact on your profitability and the value of your business, so if you wanted to pursue equity funding later on, you may be at a disadvantage.