Debt Capital vs Equity Capital Financing: What You Should Know

If you’re thinking about starting your own business, you’ll need to acquire an appropriate amount of capital. Whether it’s retail, manufacturing, business-to-business services (B2B), automotive, etc., all businesses require some initial capital to turn their vision into a reality. Without capital, you won’t be able to buy inventory, hire employees, or get your business up and running. While there are dozens of different financing options for small businesses, most fall under the category of debt capital or equity capital.

Debt Capital

The most common type of financing for small businesses is debt capital. As the name suggests, this if a financing option in which an entrepreneur or business owner receives capital while taking on debt. A bank-issued business loan, for instance, is a form of debt capital. The business owner receives capital, but only under the conditions that he or she repay it, usually with interest.

The problem many small business owners face with debt capital, however, is the strict requirements for obtaining it. Banks and other financial institutions selectively choose to whom they give debt capital. They’ll look at your business’s history, credit report, income and expenses, and other factors to determine whether you’re a suitable candidate. If you don’t have a good credit score, you may have trouble getting approved for debt capital.

Equity Capital

Equity capital differs from debt in several ways, the most notable being that it doesn’t involve debt. Unlike debt capital, you don’t have to pay back capital gained through equity financing, making it an attractive choice for smaller startups without a proven track record.

So, what’s the catch with equity capital? The catch is that you must “give up” partial ownership in your business. The financing company gives you capital, while give you the financing company equity in your company. It’s a mutually beneficial form of financing: the business owner gets the cash he or she needs to run their business, while the financing company gets partial ownership in said business.

You can typically acquire equity capital more easily than debt capital, as financing companies look at your projected revenue and profit rather than historic data. With that said, some business owners aren’t willing to give up partial ownership in exchange for capital. If you’re struggling to choose between debt capital and equity capital, weigh the pros and cons of each to determine which financing options is right for you.

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