One of my readers has recently posed the question “in what cases should a manager look at equity verses debt financing”. First let’s make sure we understand the difference between the two.
Debt financing is exactly what it says. Incurring debt (taking out a loan) to finance the start-up or purchase of a business. You can also take out a loan to grow or expand a current business. Debt financing can take on many different forms. SBA loans/lines, traditional business lines of credit/loans, equipment leasing, etc. You can also find alternative debt financing through vehicles like credit card advance funding, hard money loans and hedge fund loans just to name a few.
Equity financing typically comes from an angel investor, a venture capital firm or the like. When a group or individual makes a cash infusion into your business in exchange for an interest in your company, it is an equity investment.
As the credit markets continue to tighten, an old reliable source of financing for small businesses, the U.S. Small Business Administration (SBA) and its loan programs, is once again being looked at as a critical component in providing liquidity in the market. It is now imperative small business owners understand what is required of them to tap into this source of financing. The SBA lending market has changed dramatically over the past 120-180 days and the effect on lenders in this market has been dramatic as well. Several top SBA lenders have completely left the market with most others pulling back significantly. Losses and defaults are up and can no longer be offset with high interest rates (prime rate is at an historical low and capital costs are relatively high) or premiums earned on the secondary market, as there is no secondary market for SBA loans currently. This means SBA lenders are now approaching loans in a much more conservative manner and assessing risk instead of simply booking sufficient volume to stay ahead of delinquencies and defaults. This is being done on all loan applications, not just yours. There is going to be much more due diligence on the part of the lender and more hurdles for the borrower to jump. The days of 100% financing and fixed rate loans may be a thing of the past, but reasonable financing is still available to those borrowers willing to work a little harder and smarter.