How Will Different Finance Options Affect Profitability Or Cash Flow?

With equity financing, there are no interest payments so there is no impact on your profitability or cash flow. However, your investors may require distribution of profits in the form of dividend payments after a certain period of time. They may also have an exit strategy that requires you to buy them out at a future point in time. Both scenarios can affect your cash flow significantly.

Equity providers will become part owners in your company and will therefore be part of the decision making process. They may also insist on legal agreements that give them extensive powers such as the right to place restrictions on the business if performance does not match projections.

There may also be safeguards built into an equity finance deal to reduce the chances of failure and give the investor the right to intervene in your business if things go wrong.

With loan or asset based financing, the interest payments you make will affect both your profitability and cash flow. However, you may be able to structure the loan so that interest payments are deferred until your revenue can support the repayments.

Capital providers will want to protect their investment. Banks may require security in the form of a fixed charge against your personal or company assets that restricts your ability to dispose of those assets. They may also impose clauses that limit the scope of some of your actions.

With loan financing, you will need to meet interest payments and repayments of the principal. If your business doesn't meet these obligations, there is a risk that the bank may foreclose on you. With equity financing the capital providers share the risk and rewards but they may remove or restrict you if the business does not perform adequately.

The cost of financing depends on how much risk the lender associates with your business. The interest you pay compensates the lender for risks taken in lending. With equity financing, funding is unsecured which means a high level of risk for the equity investor. This means your capital provider must believe you have a good chance of earning a high return, usually in the form of an increase in the company's valuation.

Equity Financing		Loan Financing
Advantages	Disadvantages	Advantages	Disadvantages
Can provide a large injection of capital No interest payments No obligation to repay capital	Capital is usually only available in very large amounts It means 'selling' a part of your business Venture capitalists expect high returns on their investments (at least 25% pa) Investors may require you to buy them out at a future point	Amount borrowed can vary according to your needs As long as it is repaid it will not affect your ownership of the company	It creates a debt obligation Interest will be charge - affecting profitability Collateral is usually required & banks will value your assets conservatively If you borrow from friends or relatives it can sour relations if the business fails