Your firm’s capital structure is its mixture of external financing — typically a combination of debt and equity. Interior design business owners use this outside investment to fund everything from new hires and second studio locations to equipment purchases and product development. Debt and equity financing each have their own distinct set of advantages and disadvantages. For example, borrowing money from a bank, credit union or private party might have hefty interest fees. However, debt disappears once repaid. The lender no longer has any power over your business. On the other hand, no interest or repayment is required with equity financing. Plus, taking on an equity partner could mean mentorship and added expertise. However, business owners typically give up some level of control over their firm when selling shares to secure funding. In this post, we outline the many pros and cons of debt vs equity financing. We also explain how to position your interior design firm, so you can take advantage of both debt and equity financing as needed.

Why Access to Capital Matters for Interior Design Business Owners

Access to capital is crucial for interior design business owners. Maybe you recently founded an interior design startup or are advancing into your firm’s next stage of life. Either way, access to capital is key to a business’ financial health.

The ability to borrow money or sell shares helps owner stabilize their cash flow. It allows them to obtain necessary equipment, purchase commercial property, expand their teams, and so much more.

According to this report from the Milken Institute, “access to capital is the lifeblood of [small businesses and middle-market firms] and the overall economy.” Put simply, “how firms acquire capital and the decision-making surrounding their capital structure are important in determining the outlook for small businesses.”

Many small business owners reject opportunities to borrow money or sell equity in their firms out of fear. They fear accumulating too much debt or losing control of their firms. However, lack of financing is often the reason a business fails.

Referencing data from CB Insights and Skynova in an article for CNBC, Tom Huddleston Jr. explains. Huddleston writes that “47% of startup failures in 2022 were due to a lack of financing.” According to Huddleston, “running out of cash was behind 44% of failures…[which] can also point to a dearth of available funding.”

Let’s explore how debt or equity financing could help support your firm through economic downturns and periods of planned growth.

Debt Financing vs Equity Financing for Interior Design Firms

Access to capital allows small businesses to grow and evolve without placing the financial burden entirely on the owner’s personal income and assets. When they raise capital, business owners either choose debt financing, obtain equity financing or opt for a mixture of the two.

Debt financing involves borrowing money that must be repaid — with interest — over a certain period of time. Debt financing options might include a business loan, personal loan, revolving line of credit, merchant cash advance or commercial real estate mortgage. Once the debt is repaid, a business owner has complete control over his or her design firm. The lender does not have continuing influence over the firm’s finances or other operations.

Equity financing means selling shares in your business to equity investors — i.e. angel investors, venture capital firms or equity partners. Unlike debt financing, the owner need not return this investment in the form of credit card or loan payments. However, equity investors typically expect a share of profits and/or influence over the future of your firm.

Borrowing money makes the most sense for certain design firms, while selling shares better suits other businesses. Many interior design business owners both take on debt and invite outside investment as part of their firm’s capital structure. We outline the pros and cons of equity financing versus debt financing in greater detail below.

Pros and Cons of Debt Financing for Your Design Firm

As noted above, debt financing involves borrowing money from another person, bank, credit union, or organization like the SBA. Some opt for loans, while others opt for lines of credit (LoCs). Regardless, this money must be repaid according to the lender’s terms — usually with interest.

Debt financing is available to most business owners, though many business loans and LoCs have stricter application requirements than personal loans. For example, some require collateral and many demand a high business credit score and detailed business plan.

Loans that require collateral are called “secured” or “term loans,” while those that do not require collateral are called “cash flow” or “unsecured” loans. Most personal loans are unsecured.

Advantages of Debt Financing

One of the main advantages to debt financing is that the lender’s power over your business disappears once your debt is repaid. Unlike equity financing, a lender does not have influence over your business’ day-to-day operations or its future.

There are also tax benefits to debt financing, as you can deduct interest payments made on business loans and LoCs. Debt financing can be less expensive than equity financing because of these deductions.

The accessibility of debt financing is another advantage. Equity financing is unavailable to many businesses structured as sole proprietors, LLCs and partnerships. According to Rosemary Carlson in an article for The Balance Money, “only 0.07% of small businesses ever access the venture capital market.” Debt — on the other hand — is available in many forms to a wide range of businesses.

In many cases, business loans, personal loans and lines of credit are approved quickly — allowing business owners to access funds immediately. Plus, making regular payments on a business loan or LOC can boost your business credit score.

Disadvantages of Debt Financing

Of course, taking on debt might not be the right choice for all business owners. Debt can be incredibly expensive — especially when the interest rate is high. Unlike equity, business owners who borrow money must eventually pay it back with interest. If your business revenue fluctuates from month to month or season to season, it might be difficult to make regular payments.

Hefty balances on credit cards and a high debt to income ratio can harm your credit rating. This can also make your business less attractive to equity investors. According to this resource from The Hartford, “a business that is overly dependent on debt could be seen as ‘high risk’ by potential investors.” This perception “could limit access to equity financing at some point.”

Properly managing your business’ debt — i.e. making on-time payments, carefully reviewing loan terms and never over-leveraging — is vital. If you miss payments or default, your credit score could plummet, and you could risk losing assets used as collateral.

Types of Debt Financing

Small businesses have access to a number of different types of debt. From revolving lines of credit and short-term alternative loans to equipment loans and commercial mortgages, you have options.

In our upcoming post, we will detail all the different small business loans, RLOCs, grants and other financing options available to interior designers. For now, here’s a list of debt financing options for small business owners:

Small Business Loans from a Credit Union or Bank

SBA Loans

Equipment Loans

Merchant Cash Advances

Revolving Lines of Credit

Microloans

Short-Term Alternative Loans

Commercial Real Estate Mortgages

Construction Loans

Medium-Term Alternative Loans

Personal Loans

*Unlike business loans from a bank, credit union or the Small Business Administration, paying back personal loans will not improve your business credit score. However, interest payments made on personal loans might be tax-deductible if you use the funds solely for business expenses. As Stephen Fishman, J.D. writes in an article for NOLO, “it‘s how you use the money that counts, not how you get it.”

Pros and Cons of Equity Financing

Equity financing typically refers to public companies who seek significant investment from venture capital firms and sell smaller shares to individual investors. However, small businesses can also take advantage of equity financing as part of their capital structure.

These smaller private companies might look for equity partners, investment from family and friends, or buy-in from employees. Crowdfunding is another option that certain businesses — particularly startups — use to finance their projects. Depending on your business structure, angel investors might also be interested in helping your firm.

Advantages of Equity Financing for Small Businesses

The primary benefit of equity financing vs debt financing is that the owner need not repay investors on a set schedule with interest. Investors focus on a firm’s future profits. They hope to be reimbursed in full — and potentially exceed their initial investment — as your business grows.

If interest rates are high and your business has access to equity financing, it might make more sense than taking on debt. When cash flow is unpredictable, equity financing protects business owners from having to make large monthly payments that only debt financing requires.

Another potential benefit is that certain investors offer mentorship as well as funds. In her article “Equity Financing: What It Is, How It Works, Pros and Cons” for Investopedia, Caroline Banton explains. Banton writes that “equity financing offered by angel investors and venture capitalists can offer access to outstanding business expertise, insight, and advice.”

In addition to mentorship, investors might also “provide you with new and important business contacts and networks that may lead to additional funding.” After all, investors make money when your business succeeds.

Disadvantages of Equity Financing

Of course, there are also disadvantages to equity financing. According to Max Freedman in an article for Business.com, debt requires that you “repay loans and interest.” However, “equity financing may cost your company more money in the long run” because a portion of your profits goes to shareholders. Dividends are not tax-deductible, which can add to the cost of equity financing.

Plus, equity financing is not available to all business owners. Certain legal structures are restricted from accepting outside investment from venture capitalists and angel investors.

The main reason business owners choose debt over equity is to retain full control over their firms. Depending on the size of their investment, investors might be able to exert some control over the daily operations and future of your firm. If you hope to sell, outside investment can complicate the sale of your business.

Types of Equity Financing

In an upcoming blog post and our Summer Finance Series of workshops, we will detail all the equity financing options available to interior designers. For now, here’s a list of equity financing options for small business owners.

Keep in mind that not all will apply to your business. Access depends on your business’ specific value proposition, finances and legal structure.

Equity Partnership

Venture Capitalists

Angel Investors

IPO (for Companies Planning to Go Public)

Investment from Friends, Family and Employees

Crowdfunding

Will My Business Structure Easily Allow Equity Financing?

As noted above, not all business structures allow for both debt and equity financing. For example, sole proprietorships cost the least to maintain and are subject to minimal government scrutiny.

However, the business is not legally distinct from the owner herself — which can make getting an SBA loan or selling equity near impossible. If your optimal capital structure includes debt or equity financing, it might be time to restructure your business.

According to Nellie Akalp in this article for SCORE.org – a resource partner of the SBA and the SCORE Foundation – investors prefer corporations. Akalp writes that “most investors consider giving money to sole proprietorships risky business.” Investors rarely have interest in “funding partnerships” and venture capitalists typically reject LLCs as well.

Most investors prefer corporations — especially C-Corps — because they are legally separate from their owners. This type of business structure “provides the most personal liability protection for owners/investors (shareholders), directors, officers, and employees.”

When is Debt Financing Better than Equity Financing?

Equity financing makes the most sense when…

• You don’t want to risk losing assets used as collateral.
• Your firm is a startup with plans to scale quickly.
• You want to make connections and are seeking mentorship.
• Your firm’s cash flow is not reliable enough to cover monthly loan, credit card or LoC payments.
• You want a creative partner who helps shape the future of your firm.
• Your business structure allows for outside investment.

Debt financing makes the most sense when…

• Your firm doesn’t need a massive cash infusion.
• You want to build business credit.
• Your cash flow is reliable enough to make monthly payments with ease.
• You want to retain full control over your firm’s future.
• The funds will be used to purchase equipment or real estate.
• You have a great relationship with your bank or credit union.
• Interest rates are low and terms are favorable.

Other Funding Options for Interior Design Firms

Some funding options do not require business owners to give up partial control or pay back the investment with interest. According to this resource from American Express, “grants are one option that provides you with money that you don’t have to repay.”

Small business grants are “often disbursed by government departments, foundations, non-profit organizations, trusts [and] educational institutions.” For example, some firm owners might qualify for Interior Design Research Grants funded by ASID.

We will discuss grants and other funding options in further detail during our Summer Finance Series.

Still Have Questions About Your Firm’s Capital Structure?

Not sure what your firm’s capital structure should look like? Curious about what the optimal capital structure for design businesses might look like? Join the Design Dash private Facebook group to ask all your questions and answer a few from other interior designers.

Stay tuned for our Summer Finance Series! Over the course of several short and digestible workshops, we’ll explore debt, equity, business credit and so much more. Subscribe to our newsletter for upcoming blog posts, free downloads, workshop invites, and other Design Dash events.