9 reasons to choose debt financing over equity financing for your business!
India is amongst the fastest growing economies today, has one of the largest youth population and is home to some of the most dynamic start-up hubs. As a result, there are an increasing number of businesses cropping up every day.
However, despite the changing times and the technology-friendly world that is shrinking by the minute, the idea of debt still seems daunting to a large segment. Added to it is the misconception that the process of obtaining funds from a financial institution is cumbersome, and it often keeps businesses from exploring all their options and making an informed decision.
Today, with this article, an attempt is being made to bust that myth and show you why debt could prove both a favorable and an accessible option of funding
1. Retain ownership – Anyone who has interacted with a Venture Capitalist or a Private Equity (or watched an episode of Shark Tank) is familiar with the unavoidable haggling process that follows an offer by a potential investor. With debt, the ownership can be retained by the enterprise.
2. Retaining control – The enterprise can fully retain control of the decision making and the management of the business, which may not be the case with an equity investor. Ask a passionate biker what it’s like to sit pillion on a long ride! The lender will wish to periodically review the financial statements and analyse the cash-flows of the enterprise, but will not have a say in how the business is run.
3. Retaining profits – Equity funding will mean sharing your profits with the investors, which no business would like to if avoidable. It’s human nature to want to have our cake and eat it too! With loans, apart from repayments within agreed timelines, the business can retain its entire profits.
4. Predictability, leading to easier planning – Surprises are fun in the context of parties and celebrations, but businesses? Not so much. With loans, the exact amounts of periodical interest and principal payments is always known, and well in advance. This greatly facilitates the financial planning and budgeting process of the enterprise.
5. Flexibility in period –Loans can be sought for whatever time period the enterprise decides it needs funding for. And once the same is repaid, the business relationship ends. It is far less interfering in the business than equity funding would be. And who doesn’t like a little more flexibility and a free-hand in running their business?
6. Lesser / no potential for conflict –Decisions of an enterprise are made with the consensus of its investors. Conflicts may arise from difference of opinions, management styles, etc. This risk is reduced largely by choosing debt financing over equity financing since the lender will not be an investor, and will not interfere in day-to-day affairs or the management of the enterprise. Less battle of wills, more battle of wits!
7. Tax benefits – Dividends paid to shareholders are not tax deductible, but interest paid on loans is. Small joys amidst the otherwise not-so-enjoyable process of parting with a part your earnings!
8. Available to businesses of every size – There are multiple financing options which are not accessible to smaller businesses, due to eligibility criteria. Loans are made available to enterprises across industries, irrespective of the size of the business, and you avoid the fall at this hurdle
9. Builds / improves business credit score – An added bonus, the entity can build a good credit score by making timely payments, which in turn demonstrates responsibility and credit worthiness to not only lenders, but also to vendors and the market.
While looking to finance or further finance a business, generally, a mix of various means is chosen, and practically, loans are an indispensable means of financing for a business of any size. A mentor of mine often repeats – ‘Establish the intention and the ability of person to repay, and he will be given the loan!’, and with time, I’ve come to realise that that’s truly all there is to it!
Srividya is a Bangalore based finance professional who has as much interest in articulating her opinion as observing how finance works differently for different people. Her writing is peppered with anecdotes from an active lifestyle that extends to hobbies beyond her career such as travelling, classical dance and volunteering. She is also a voracious reader and takes keen interest in all art forms. Professionally, she is a credit analyst and works towards your every financial need as part of Team Capital 9!