Small business owners must choose between debt and equity financing; if you’re just starting your business, you may be confused by the advantages and disadvantages of each plan.

Simply put, ‘debt’ financing involves borrowing money to be repaid, plus interest. Equity financing involves raising money by selling interests in the company. Each plan has its pros and cons.

Debt’s Advantages

• Debt does not dilute the owner’s ownership interest in the company
• The debt’s interest can be deducted on the tax return, thereby lowering the cost of the loan
• The company is not required to comply with securities laws and regulations, so raising debt capital becomes less complicated
• The company does not have to send notifications to many investors, nor does the company have to hold meetings with shareholders

Equity’s Advantages

• Debt must be repaid at some point, while equity does not
• Companies with a large amounts of debt compared to amounts of equity have difficulty growing
• Debt instruments – means of transferring debt ownership from one party to another – often restrict a company’s activities, not allowing management to pursue other financing options
• The company must pledge its assets to the lender as collateral; sometimes, the owners of the company have to personally guarantee that the loan will be repaid.

After investigating the pros and cons of each plan, you’ll be able to make a reasoned decision about how you finance your small business.

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