What’s better for business?
Debt and equity serve one function in your business: to supply the funds needed for your business to grow and expand. However, debt and equity vary in how they enable that to happen and the level of responsibility (and potentially stress) that they place upon you, as the owner.
Equity
Equity in a business is the value of your assets minus your liabilities. Equity represents the funds contributed by shareholders plus any retained earnings to form ‘shareholder equity’ on your balance sheet.
Positives
- Equity is useful for small businesses as you are not borrowing money from anyone.
- Equity by definition is what someone (a shareholder) has invested in your business, therefore they do not need to be repaid with interest (they won't see a return, which is the whole reason they are investing in the first place).
- Investors in your business often have business experience and can offer advice, moral support, and assistance (however, you’ll want to carefully select your investors if this is important to you).
Negatives
- However, due to the fact that equity involves the investor owning a portion of your business, you will need to be cognisant of your reduced bargaining power when it comes to making business decisions. When you move from a single shareholder (you) to a number of shareholders, the power balance shifts.
- The shareholders will also have a claim to future profits that the company may generate, therefore decreasing your income as the business owner.
Debt
Debt is the amount of money that your business has borrowed from a lender, on the condition that it will be repaid at a later date with interest. The most common form of debt is a loan. Debt is often used by businesses to expand operations, such as making purchases it couldn’t usually afford to make.
Positives
- Debt is the favoured tool for business expansion as it means that you don’t have to give up any ownership or control.
- Debt doesn’t require communication with large numbers of investors and doesn’t require a vote from shareholders when important decisions need to be made.
- Interest on the debt is tax deductible thereby allowing a company to have less of their income taxed.
- The lender doesn’t have any claim to the future profits of the business, therefore if your business turns over greater revenue due to an expansion funded through a loan, you don’t have to share that income with shareholders.
Negatives
- Debt is not only repaid at a future date but it also has an interest payment attached to it, therefore you will almost always pay more than the value of the loan.
- Debt is often secured against company assets, and if you default on your loan the lender can seize your business assets to recoup the cost of the loan.
- As your business undertakes more debt, lenders will be less willing to lend you more money as you’re already managing debt.
What’s the verdict?
The answer will require you to analyse your personal situation and explore whether one or the other - or a blend of the two - is optimal for your small business.
Debt has many benefits over equity, however, as your business increases its amount of debt it can lead to a greater risk of bankruptcy.
Equity must be able to supplement debt in order to provide additional support for a business, without sacrificing too much control over your business.
When making important financial decisions, we strongly advise that you consult your accountant or business advisor and ensure you receive tailored advice.
Nathalie is the Communications Manager at Valiant Finance. She has a double degree in Journalism and Law, and a background in the fintech space, hailing from Asia's largest fintech hub, Stone & Chalk.
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