Equity vs debt: The different ways to fund your startup
You've got the idea, the skills, the hunger for success — but what about the capital? Any plans you have can only be achieved if they're backed by steady investment. So, if you have a clearly articulated elevator pitch for your product or service, you might be asking, "is debt or equity financing the better choice for my startup?"
There's more than one way to fund a new business venture and maximise its growth potential. Bringing in funding will at some point be necessary, whether it's to get your business off the ground, expand on what you're already doing or create an emergency capital stream.
There are two key types of financing: equity and debt. And both options have their pros and cons. Consider whether you want things like cash flow flexibility or complete control over your business to decide which avenue is right for your startup.
Let's look at how to decide on your startup funding game plan. But first: let's explore the key differences between debt and equity financing.
What is debt financing?
Debt financing offers your business a cash injection without having to give up any equity in your startup. This method involves borrowing money from others and paying it back in instalments over a fixed period at a predetermined rate. How quickly you'll need to pay back your debt will depend on where you've borrowed it from.
What is equity financing?
Equity finance is the most well-known form of startup funding and involves exchanging capital for ownership rights in your business.
Sources of equity financing often come from close business partnerships but can also be sourced from:
VC funds from venture capital firms
The public in the form of an IPO (initial public offering)
With equity financing, there are no fixed repayments to be made. Instead, your equity investors will receive a percentage of your company's profits, depending on how much stock they were given as part of the initial arrangement.
How do startups get funding?
Here are some ways your startup can obtain funding so you can hit the ground running. These are examples of both debt and equity financing types.
The phrase 'angel investors' can be pretty apt for startups, as their investment can be a miracle for small businesses that are just getting going. Angel investors typically invest in startups or companies in their early stages in exchange for an equity ownership interest.
The typical angel investment is USD 25,000 – 100,000 per company; however, this depends on the market opportunity your startup addresses and evidence of traction. Uber, WhatsApp and Facebook were all supported in their early stages by angel investors.
You can find Angel investors through:
Angel syndicates (platforms to access a network of angels interested in investing into a pool of funds on a deal-by-deal basis)
Startup accelerators and incubators
Networking with other entrepreneurs
Speaking with lawyers and accountants
Specific angel investor networks
Crowdfunding involves raising capital through multiple investors, often through websites that are specifically designed to secure crowdfunding opportunities.
Setting up a crowdfunding campaign is pretty simple, and people will usually donate to your campaign in exchange for a reward. For example, you may offer one of your products or services in exchange for a donation or some form of equity or profit share in your business.
To run a successful crowdfunding campaign, you'll need to create an engaging story about your company, so you can really show potential donors what your business is about and the mission you're trying to fulfil.
Some of the most popular crowdfunding sites include:
Venture Capital (VC funds)
Although not easy to secure, VC funding can provide much more than just capital. Firms can also provide strategic business assistance, new employees, and networking opportunities with customers and partners.
VC firms usually want to invest in startups that are pursuing big ideas and a high-growth mindset and those that have already shown some promising success, whether through a great product prototype or early customer support for the startup's offering.
Traditionally, VC investments have been a local activity, but new opportunities in emerging markets and the rise of global payments are seeing capital flow across borders.
It's important to remember that VC firms get inundated with daily investment requests, so work hard on your elevator pitch beforehand and make sure you have a truly engaging presentation deck to work from. Even better, secure an introduction to a venture capitalist through a friend, family member or business associate.
Small business credit cards
Some traditional banks offer credit cards specifically catering to the small business market, including perks like cash back rewards, airline points or other small rewards.
Small business credit cards offer a good level of flexibility for your startup's funding needs. However, interest on unpaid balances can often be relatively high, ranging from 5% to even 19.9%.
It's important to take into account that small business credit cards will often need to be linked to the owner's personal accounts, meaning that any late payments will affect your personal credit score.
If you're confident you'll be able to make your repayments on time and you find an issuer with a reasonable interest rate, a small business credit card can be a good option for flexible startup funding needs.
What are the pros and cons of debt financing?
Pros of debt financing
No loss of control or ownership. With debt financing, you get to retain absolute control of your business (not to mention keep all the profits). You get to make the decisions and decide which directions your business goes in in the future.
You won't be in debt forever. You can repay and borrow as much as you need to at any time, and you only pay the interest you need to. Once you've paid back your debts, your liability is over.
Tax deductions. An often overlooked pro of debt financing is creating more tax deductions down the track. This may not have a significant impact in the early stages of your business, but it can have a massive difference in net profits as your business grows and brings in higher revenue.
Cons of debt financing
Non-flexible repayments. The main downside of debt financing is that the money needs to be paid back no matter how well or poorly your business is performing. This revenue pressure can be a major downfall for startups if cash flow isn't adequately managed.
High-interest rates for startups. Investing in startups is risky for traditional banks, given the high failure rate of businesses. So, to cover up or compensate for losses, debt funding means investors can lend funds at higher interest rates.
What are the pros and cons of equity financing?
Pros of equity financing
Larger cash injections. As we mentioned earlier, traditional banks are notoriously reluctant to loan what they deem to be large amounts of money to small businesses. Your business' growth could be capped depending on how reliable your access to healthy cash flow is without equity capital startup funding.
Cash flow flexibility. Another benefit of equity financing is that you don't have any debt to pay if you aren't profitable. This 'stress less' approach can be beneficial to businesses, as founders feel empowered to make intelligent decisions that aren't based on the crushing fear of not making debt repayments.
Mentorship and networking opportunities. Obtaining your startup funding through VC funds can open your business to a wide variety of investors who are experienced, invested or simply just interested in your industry. There's much to learn from others in the early days, so connecting with other founders can be invaluable.
Cons of equity financing
Giving up total business autonomy. Having multiple rounds to secure VC funds will hold your business in good stead, but it also takes away the indepence of the founder. Having financial partners means giving up a certain percentage of control, which can impact every single area of your business.
You'll have to split the profits. Equity financing means that not every dollar your startup makes will go back into the business. Unfortunately, your investors may be entitled to your positive returns before you even receive a penny.
Stretch your startup funding further with Airwallex
Securing funding for your startup requires a great deal of consideration. Thankfully, a truly innovative solution exists to collect and hold your startup funding and solve business cash flow problems.
Airwallex offers a borderless business account that allows you to seamlessly receive funds from overseas investors without losing any profit margins in unnecessary FX fees. You can collect payments from any funding source (such as VC firms or angel investors) in any currency with no forced conversions.
As well as being able to receive all-important startup funding from your investment sources seamlessly, you can also create borderless cards for your team in minutes and manage your startup expenses from anywhere in the world with no transaction fees.
These small savings can really add up over time if your business engages in consistent foreign investment activities or receives regular investment injections from overseas. With a borderless Airwallex account, you also won't need to worry about navigating local banking or legal regulations – you can leave the complexity to us.
Ready to take your startup even further? Add 3% back to your bottom line with global business accounts, multi-currency wallets, and payments services that bypass hidden fees and wasteful overheads. Create your free borderless account within minutes.
Writer, content strategist and storyteller. Shani is a digital marketer with a passion for brand storytelling and empathy-led copywriting. Responsible for Airwallex's content marketing efforts in Australia, and other parts of the world.
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