Starting a business is a complicated task even for experienced entrepreneurs, and financing has always been one of its first difficulties. An entrepreneur has a choice of different ways to find start-up capital, ranging from debt to equity. However, various factors, such as the level of risk and the stage of the company’s development, play an important role in deciding which source of capital to choose. This paper explains the difference between debt and equity and explicitly describes ways to find start-up money.
Debt financing is one of the most common ways to fund a new venture. Taking on debt as a source of capital implies a payback with interest. An entrepreneur can choose short-term borrowing for a period of less than a year and long-term debt, which can be paid back even after five years (Kuratko, 2016). In most cases, newly established ventures incur debt from commercial banks, where the majority of bank loans are secured. However, the procedure of taking a loan requires an entrepreneur to answer several questions aimed at evaluating the risk of the venture, the term of the debt, and the ability to repay the loan. As for long-term loans, they can sometimes be provided by manufacturers (for example, if they are interested in reselling their used equipment). Another common source of loan money is peer-to-peer lending, which can be described as financing the ventures of unrelated individuals and avoiding bank formalities (Kuratko, 2016). Other common debt sources include trade credit, accounts receivable financing, factoring companies, and finance companies.
Equity is a different way of financing a venture; it is a loan that does not require repaying the amount or paying interest. At the same time, this type of financing is based on partnership and requires an entrepreneur to share a part of the business and its profits with the source of funding. Such business relationships are regulated by various equity instruments, such as loans with warrants (the rights for investors to purchase stock) and convertible debentures, which are loans convertible into stock. Other partnership instruments are preferred stock, providing investors with preference among other creditors, and common stock, giving stockholders voting rights (Kuratko, 2016). Equity sources of financing include public offerings (the sale of securities on public markets) and private placement of securities. Moreover, a company can raise money with the help of “sophisticated” investors, regularly investing in early- and late-stage ventures, and crowdfunding, a source of financing from a large number of people.
Based on the discussion of the two sources of start-up capital, it is possible to name two main differences between them. Firstly, in the case of a debt, entrepreneurs need to repay the principal amount with interest; in the case of equity, it is not needed. Secondly, equity requires entrepreneurs to share a part of the business with an investing party. Therefore, when deciding what source of financing to choose, an entrepreneur needs to evaluate whether payback and regular interest payments or sharing ownership would be a better solution for an emerging venture. According to (Kuratko 2016), the combination of debt and equity is usually the most appropriate solution for the company. However, it is a task of an entrepreneur to define the level of risk and forecast the development of the venture in order to make the right decision.
Ways to raise funds for a start-up are not limited to debts and equity. For example, Jangir (2021) mentions that it is possible to grow a business from profits alone. When discussing the disadvantages of venture capital, the author reminds that it implies a degree of external influence on how the company operates. Besides speaking about bank loans, Jangir (2021) adds revenue-based financing, which means that some percentage of future revenues is exchanged for current capital. Similarly to Kuratko (2016), Jangir (2021) concludes that the best option for an emerging company is to use a combination of financing sources. It is possible to notice that using several sources of income is commonly considered the least risky choice.
If talking about real-life experience, many companies were able to develop from small projects to business giants. One of them is Facebook – a social network that now connects millions of users around the world. The history of Facebook dates back to 2004 when Mark Zuckerberg and a group of his university friends decided to create a system allowing students to communicate online. In the beginning, financing came from creators themselves, who invested in launching a website. Later, Peter Thiel, the co-founder of PayPal, became the first major investor of the start-up. As the company developed, it received financial support from venture capital companies and large organizations, such as Microsoft, which purchased Facebook shares. As a result, after years of fast development, students’ start-up turned into one of the most successful companies in the world.
In conclusion, it is possible to say that establishing a venture demands making important decisions, some of which are connected to finding sources for financing a start-up. Taking on debt and giving away equity are some of the most common ways to raise start-up money. Each has its advantages and drawbacks, and an entrepreneur needs to carefully evaluate all risks and opportunities to choose a better option. However, the common opinion is that the combination of debts, equities, and other financial sources is the most reliable way to raise funds for an emerging business.
References
Jangir, A. (2021). Raising funds for your startup: 4 ways to fund your business other than venture capital. Financial Express. Web.
Kuratko, D.F. (2016). Entrepreneurship: Theory, process, and practice (10th ed.). Cengage Learning.