Equity Financing vs. Debt Financing: What Option Is Best For Your SMB?

equity vs debt financing - whats the best option for your small business (SMB)

Smaller businesses typically need funding. This is particularly true for businesses that are just starting.

There are often two choices available when a small business needs outside funding for expansion or other reasons—equity financing and debt financing.

Both of these options provide money, but each has advantages and disadvantages. Debt financing can be pricey, particularly if your credit is poor. At the same time, equity financing necessitates giving up a share of your business and allowing investors to have a say in operational decisions.

As a small business owner, which option is best for you?

What is Equity Financing?

Equity financing is giving investors a stake in your business in exchange for a share of any future revenue. Business owners that choose this option won’t have to pay high-interest rates or make monthly repayments. Rather, investors will be partial owners with the right to a share of company profits and possibly even a say in managerial decisions based on the conditions of the sale. There are various ways to get equity financing, including through equity crowdfunding or a deal with a venture capitalist.

Benefits of Equity Financing

The fact that the investor bears all the risks makes equity financing extremely advantageous. You are not required to repay the money if your business fails. Additionally, you will have more money available since there are no loan repayments. Furthermore, investors have a long-term perspective and are aware that business growth takes time.

Drawbacks of Equity Financing

The drawback is significant. You will need to give the investor a share of your business in exchange for the funding. When making decisions that will have an impact on the business, you will be required to consult with your new partners and split any profits. The only option to get rid of investors is to buy them out, which will probably cost more than the money they gave you in the beginning.

Types of Equity Financing:

Equity crowdfunding

Equity crowdfunding refers to selling small shares of your business to various investors through crowdfunding platforms. These campaigns typically involve massive marketing efforts and a lot of preparation to reach the target and get funding.

Angel investors

An angel investor is a wealthy person who provides a business with a significant inflow of capital. The angel investor receives equity, a share of the business, or convertible debt in exchange for their investment.

Venture capitalists

A venture capitalist is an entity that invests money in businesses, typically high-risk startups. They can be a group or an individual. Most of the time, the startup’s growth potential outweighs the investor’s risk. In the long-term, the venture capitalist might consider purchasing the business or, if it is public, a sizable part of its shares.

What is debt financing?

Many of us have taken out loans at some point, whether for a home or college fees. It’s similar to debt financing a business. The borrower takes money from a third party and makes a repayment commitment that includes both the principal and interest, known as the “cost” of the initial loan.

After that, borrowers will make regular payments toward interest and principal and provide some assets as security for the lender in the form of collateral. Real estate, inventory, accounts receivable, equipment, and insurance policies are collateral that may be used as repayment in the event the borrower fails on the loan repayment.

Benefits of Debt Financing

Debt financing has a lot of benefits. Firstly, your relationship with the lender is over once you have repaid the debt. Again, your business is not under the lender’s control. In addition, interest payments are tax deductible. Last but not least, since loan payments are consistent, expenses are easy to predict.

Drawbacks of Debt Financing

Anyone who has debt can relate to the drawbacks of debt financing. Debt is a wager on your ability to repay loans in the future. What if your business faces challenges if the economy collapses once again? What if business growth is slower or less successful than anticipated? Debt is an expense, and expenses must be paid on a regular basis. And this can hinder the growth of your business.

Furthermore, even if you operate as a limited liability company (LLC) or another business entity that helps keep corporate finances separate from personal ones, the lender may still need you to guarantee the loan with your family’s assets.

Debt Financing or Equity Financing: What Is Better for My Business?

Depending on the amount of capital you need and your business size, you may benefit more from equity financing than debt financing for your start-up expenses. Equity finance can be a better option if you require hundreds of thousands of dollars to launch your business. On the other hand, if you only anticipate needing a few thousand dollars to start, borrowing from a friend or member of your family or even taking out a small bank loan may be easier and more cost-effective.

Final thought

Your startup will have the most significant impact on the type of finance you seek. Consider taking out a loan from a family member, friend, or bank if you are just starting out and can do so with little capital. Equity funding can be more attractive if you are willing to sacrifice a share of your business as you expand and reach a broader market.


Which financing option is the least expensive?

Most of the time, a traditional loan or traditional line of credit from a bank or another lender is the least expensive source of capital for a small business.

Why is equity financing more expensive than debt financing?

Debt financing is less expensive than equity financing partly because interest paid on debt can be deducted from a company’s taxes, but the interest paid on equity cannot.

What are the top five financing resources?

Personal savings, relatives and friends, business loans, angel investors, and venture capitalists are the most typical sources of funding for startups.