I run a startup that provides fund-raising solutions to entrepreneurs, and a perplexing question that is often put across to me is – DEBT or EQUITY financing?
Each time a startup succeeds, it aspires for more success in the near future. Moreover, today the parameter of success is equated with the capital that stands in accounting books. Many startups fail to take corrective decision to raise funds optimally and end up with larger cost in the form of Interest that reduces their profit and adds to liabilities. Most entrepreneurs believe that equity is a cheaper source of finance, but as a chartered accountant, I like to draw their attention towards the fact that in many situations, debt is actually the cheaper source of finance. The question arises, how? In equity suppose you have earned Rs. 100 but you will end up paying Rs. 30 to the tax department and be left with only Rs. 70. However, in case of debt financing you will enjoy the following benefits:
- You have to pay interest on only the amount which you have taken as loan
- You can pay off the loan in the desired no. of instalments
Debt financing allows new startups to pay for buildings, equipment and other assets for growing their business much before the projected earnings begin to materialize. Hence, this can be an excellent way to pursue an aggressive growth strategy, especially with access to low-interest rates. Closely related is the advantage of paying off the debt in instalments over a period. Compared with the equity financing, debt financing benefits can be enjoyed by not relinquishing any ownership or control of the business.
However, before raising funds, you should be ready with answers to the following questions that will facilitate the process:
- How much money is needed to run/initiate the business?
- How will the money be used i.e. disbursement criteria?
- What is the collateral security and its value?
- Who will be the guarantor?
- How will the loan be repaid?
A startup at initial stages obviously will not have multiple properties to be provided as collateral. However, this should not be a worry as in such cases you can opt for the option of ‘collateral-less debt financing’.
Understanding this fundamental problem of startups, the government has launched the CGFSIL scheme where new startups can acquire a loan from ‘Startup India, Stand Up India’ initiative. They can go for composite loans (inclusive of the term loan and working capital between Rs. 10 lacs to Rs. 100 lacs) and can enjoy benefits of lower interest rates as compared to other banks (i.e. MCLR +3% + Tenure).
Thus, think big, explore new ideas, innovate your future and forget the rest because there are measures available to help you to fulfil your dreams. Debt financing is the key to your successful business provided you have a good enough credit rating and the financial discipline to make repayments on time. However, by agreeing to provide collateral to the lender, you may be putting some business assets at potential risk. Hence, a note of caution is obvious.