When small business owners are considering their options, for financing, it

usually comes down to one of two options. Those options are debt or equity

financing. It is important to understand that there are significant differences

between the two, along with equally significant ramifications. Savvy business

owners will do well to fully educate themselves, about both choices, before

making a final decision. Here is what you need to know about how to choose

between equity or debt financing-

Remember that all money is not the same. This is especially true

when it comes to equity, and debt financing. When you are looking for

money, you must consider your company's debt-to-equity ratio (the relation

between dollars you've borrowed and dollars you've invested in your

business). This is because the more money owners have invested in their

business; the easier it is to attract financing. No matter what method you end

up choosing the first step is to become educated about both ways of

financing.

Debt Financing-There are many sources for debt financing: banks, savings

and loans, commercial finance companies, and the U.S. Small Business

Administration (SBA) are the most common. In addition, state and local

governments have developed many programs in recent years, to encourage

the growth of small businesses in recognition of their positive effects on the

economy. You may also want to consider family members,

friends, and former associates as all potential sources of financing, especially

when capital requirements are smaller. However, traditionally, banks have

been the major source of small business funding. Their principal role has

been as a short-term lender offering demand loans, seasonal lines of credit,

and single-purpose loans for machinery and equipment. Banks typically have

been reluctant to offer long-term loans to small firms. It is important to

realize that lenders commonly require the borrower's personal guarantees in

case of default. This ensures that the borrower will have a sufficient personal

interest at stake to give paramount attention to the business. For most

borrowers this can be a burden, but also a necessity

Equity Financing-Most small or growth-stage businesses use some form of

limited equity financing. Additional equity financing, often comes from non-

professional investors such as friends, relatives, employees, customers, or

industry colleagues. However, the most common source of professional

equity funding comes from venture capitalists. These are institutional risk

takers, who can be groups of wealthy individuals, government-assisted

sources, or major financial institutions. Keep in mind that most of these

investors specialize in one, or a few closely related industries. Venture

capitalists are most often portrayed as deep-pocketed financial gurus, who

are looking for

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start-ups, in which to invest their money. However, you may be

surprised to learn that they most often prefer three-to-five-year old

companies, with the potential to become major regional or national

concerns, and return higher-than-average profits to their shareholders.

Venture capitalists may scrutinize thousands of potential investments

annually, but only invest in a handful. Quality management, a

competitive or innovative advantage, and industry growth are also

major factors that they will consider before investing in your business.

It is important to understand that different venture capitalists have

different approaches to management of the business in which they

invest. Most (but not all), generally prefer to influence a business

passively, but will react when a business does not perform as

expected, and then may insist on changes in management or strategy.

Giving up some of the decision-making, and some of the potential for

profits, are the main disadvantages of equity financing.

Finally, many financial experts recommend that if your business has a

high ratio of equity to debt, you should probably seek debt financing.

However, if your company has a high proportion of debt to equity,

experts advise that you should increase your ownership capital (equity

investment), for additional funds. Using this method, you won't be

over-leveraged to the point of jeopardizing your company's survival.

Introduction:

Businesses need finance, either to expand an already existing business, or to start a new one. There are three alternatives for financing a business, namely, self financing, equity financing and debt financing. Self financing involves a huge risk and is generally taken up by small business owners. That leaves us with the other two financing methods, that is, debt and equity financing. Let's compare debt financing vs equity financing on various counts, but before that its important to understand their meaning.

Definition: Debt Financing Vs Equity Financing

Debt financing means when a business owner, in order to raise finance, borrows money from some other source, such as a bank. The business owner has to pay back this loan or debt within a pre-determined time period along with the interest incurred on it. The lender has no ownership rights in the borrower's company. Debt financing can be both, short term as well as long term.

Equity financing means when a business owner, in order to raise finance, sells a part of the business to another party, such as venture capitalists or investors. Under equity financing, the financier has ownership rights equivalent to the investment made by him in the business, or in accordance with the terms and conditions set between him and the business owner. This is the main difference between debt financing and equity financing. In equity financing, the financier has a say in the functioning of the business as well.

Debt Financing Vs Equity Financing

Process: Procedure of raising money through debt financing is easier, than raising money through equity financing. In equity financing , there are a number of security laws and regulations, which have to be complied by the business. Such rules are not applicable for debt financing.

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Ownership Rights: In debt financing, the business owner has full control and ownership of the business. In equity financing, the investor or the venture capitalist has ownership rights, as well as decision making power, in running the business.

Rights over Profit: In debt financing, the lenders only have a right over the principal loan and the interest incurred on it. They have no rights over the profits or revenues generated by the business. Once the loan is repaid, the relationship between the lender and the business owner also, ends in debt financing.

Ease of doing Business: In debt financing, decisions and rights regarding running the business, solely lie with the owner. Whereas in equity financing, the shareholders and investors have to be updated and consulted about the business regularly. So, it is easier to do business with debt financing, than with equity financing.

Repayment : In debt financing, the business debt has to be paid back within a given period of time. If for some reason, the business does not make enough profits or is going through a loss, there is a lot of pressure on the business owner to repay, as an increased time period of repayment means an increased interest on the loan. As far as equity financing is concerned, the pressure to repay is comparatively lesser. The revenue which the business makes is used to repay the lenders.

Cost to Company: In debt financing, the loan amount is already known and fixed, so the business owner can make a provision for it beforehand. Also, the interest incurred on loan in debt financing can be deducted from the corporate tax . Thus, cost to company in debt financing is easy to forecast, plan and reimburse. On the other hand, in equity financing, if the business generates huge profits, the investor and the venture capitalist have to be paid back money, which is much in excess of the amount they invested.

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Future Funding: If the investors are backing the business, there will be no problem in arranging finance for the business in future, as investors lend credibility to a business and lenders will have no reservations in giving loans to such businesses. Thus, equity financing improves the scope of arranging financing for the business in future. However, if the business has taken too much loan, that is, its debt to equity ratio is on a higher side, the investors will not like to invest in such a business as it's a "high risk" venture.

Thus, after comparing debt financing vs equity financing, it can be concluded that both have their pros and cons. Ideally, a business should have a mix of debt and equity financing with the debt amount comparatively low, so that debt management becomes easy. However, it's up to the owner of the business to decide where his preferences lie. A business owner who wants full authority over the business, should choose debt financing .While an owner who is willing to share his risks and profits should opt for equity financing.

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Credit evaluation and approval is the process a business or an

individual must go through to become eligible for a loan or to pay for

goods and services over an extended period. It also refers to the

process businesses or lenders undertake when evaluating a request

for credit. Granting credit approval depends on the willingness of the

creditor to lend money in the current economy and that same lender's

assessment of the ability and willingness of the borrower to return the

money or pay for the goods obtained—plus interest—in a timely

fashion. Typically, small businesses must seek credit approval to

obtain funds from lenders, investors, and vendors, and also grant

credit approval to their customers.

EVALUATING CREDIT WORTHINESS

In general, the granting of credit depends on the confidence the

lender has in the borrower's credit worthiness. Credit worthiness—

which encompasses the borrower's ability and willingness to pay—is

one of many factors defining a lender's credit policies. Creditors and

lenders utilize a number of financial tools to evaluate the credit

worthiness of a potential borrower. When both lender and borrower

are businesses, much of the evaluation relies on analyzing the

borrower's balance sheet, cash flow statements, inventory turnover

rates, debt structure, management performance, and market

conditions. Creditors favor borrowers who generate net earnings in

excess of debt obligations and any contingencies that may arise.

Following are some of the factors lenders consider when evaluating

an individual or business that is seeking credit:

Credit worthiness. A history of trustworthiness, a moral character,

and expectations of continued performance demonstrate a debtor's

ability to pay. Creditors give more favorable terms to those with high

credit ratings via lower point structures and interest costs.

Size of debt burden. Creditors seek borrowers whose earning power

exceeds the demands of the payment schedule. The size of the debt is

necessarily limited by the available resources. Creditors prefer to

maintain a safe ratio of debt to capital.

Loan size. Creditors prefer large loans because the administrative

costs decrease proportionately to the size of the loan. However, legal

and practical limitations recognize the need to spread the risk either

by making a larger number of loans, or by having other lenders

participate. Participating lenders must have adequate resources to

entertain large loan applications. In addition, the borrower must have

the capacity to ingest a large sum of money.

Frequency of borrowing. Customers who are frequent borrowers

establish a reputation which directly impacts on their ability to secure

debt at advantageous terms.

Length of commitment. Lenders accept additional risk as the time

horizon increases. To cover some of the risk, lenders charge higher

interest rates for longer term loans.

Social and community considerations. Lenders may accept an

unusual level of risk because of the social good resulting from the use

of the loan. Examples might include banks participating in low income

housing projects or business incubator programs.

Read more: Credit Evaluation and Approval - advantage, percentage,

type, benefits, disadvantages, cost, Evaluating credit worthiness,

Obtaining credit approval from lenders, Granting credit approval to

customers http://www.referenceforbusiness.com/small/Co-Di/Credit-

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