By Chris Wild

So you want to start up a new business? Or perhaps you have already tested the waters and are ready for expansion. Presumably, you have given this business idea a good deal of thought and if you are serious enough, you have reached the point where your research is done, have committed your plans to paper and you are ready to look at your financing options.
But what ARE your financing options? How do you go about choosing them and why? And who can (or should) you go to in the best interests of your business?

There are many finance concepts that one has to deal with when starting up or expanding a business. Whether it is loans and interest repayments, tax, shares and equity, everyone who starts a business will encounter these concepts and it’s best that you at least have a little bit of knowledge to help you out.

Equity financing
This can be a solid option for an entrepreneur and involves bringing a venture capitalist into the business. This would typically be a person or an entity that is willing to give you the capital you need in order to start or expand your business without asking for any repayment of the money.

So where's the catch? When things sound too good to be true, they usually are. In the case of equity financing the person writing the cheques won't just do it for free, but will want a share in your business and of course a proportion of the profits.
The first drawback here is that you lose control (or at least partial control) of the running of the business. You cannot make management decisions on your own – you must consult your shareholder as it is also his or her money at stake.
Losing control of one's own business is probably the main reason people shy away from equity financing. It also becomes very important who you choose as your equity financier, as finding someone who can suit the needs of your business and let you run things the way you envisage can be a fairly hard task.

However it is certainly not all bad and there are a number of positive factors which may lure you to choose equity financing over debt financing. Firstly, equity financing is much less risky than a loan, simply because you will not have to pay anything back even if the business fails.

Secondly, because you're not paying back the interest on a loan every month, you'll have a lot more cash to play with. Not only does this help with the cash flow of your business, but it also allows for a more rapid expansion as profits can be poured back into the business rather than them having to go into paying back debt. Another great advantage of equity financing is that it always leaves open the option to take a further loan if need be.

Debt financing
Debt financing involves borrowing money which must be repaid over time, usually with interest. This can either take the form of a short-term loan (under a year) or a long-term loan (more than a year). In SA, the main sources of debt financing are usually the retail banks and other financial institutions. However, due to the nature of our government’s interest in the small business sector, loans from government-related sources can also be accessible to new start-up businesses.
You need to read and understand all the fine print in any loan contract, so you can build it into your long-term strategy without any surprises. In the case of the government, there may also be additional conditions which should be looked into carefully.
One of the main advantages of debt financing is that the bank or lending institution never has a say in the way you choose to run your company. Because the bank has no ownership in your business, a start-up entrepreneur is allowed to make all the decisions s/he deems to be in the company's best interests. Also, because the principal amount of the loan plus the interest and the terms are all known beforehand, you can plan ahead and build the initial financing into the company's strategy.
Another advantage of debt financing comes in the form of tax. By law, interest on the debt is allowed to be deducted as a legitimate company expense. This lowers the overall cost of the loan as one can simply “put it through the business”. Also, in general, when compared with equity financing, debt financing requires a lot less administration.
However, there are also significant disadvantages to debt financing. The first (and most apparent) is that ultimately the money you borrow has to be paid back. Therefore careful planning and strategies must be put in place so your cash flow is not affected. Also, borrowing from a bank significantly restricts your options of obtaining further capital. While you can get permission from an investor to borrow more money, it is unlikely that an investor will invest in your business if it has a high debt ratio. Lastly, no bank or institution will lend you money without some form of collateral. These assets, especially for business start-ups, have to be put down by the business owner beforehand. This often means that should the company fail, not only do you find yourself out of a job, but you could lose your house, car or anything else that you have put on the line in order to start.
The way in which you choose to finance your entrepreneurial venture is ultimately up to you. You need to weigh up what you can and cannot do. The decision is certainly not an easy one and can often depend on what options are available to you.
The truth is, all businesses require some form of capital in order to succeed. The wisest course of action may simply be to obtain capital from a number of sources, and see if you can use both debt and equity financing to start or grow your business.