- How debt and equity financing compare
- What type of debt financing options are available to café owners
- Which type of financing may be best suited to your business needs
To begin, let’s look at debt and equity financing in more detail.
Debt vs. Equity Financing: What’s the Difference?
Debt and equity offer two unique avenues for raising capital for your café. Equity financing means offering an ownership stake in your business in return for upfront capital. This funding may come from angel investors, venture capitalists, peer-to-peer investors or friends and family.
One advantage of equity financing is that businesses can raise it at an early stage without much—or for that matter, any—operating history. So, if you’re planning to open a coffee shop, looking to friends and family as a source of capital is a safe place to start. However, equity investments are primarily geared towards high-risk technology and innovation startups, with the potential to generate a huge return on investment.
For those who’ve already established a café that’s doing steady trade, debt financing is likely to be the better option. It’s pretty straightforward: you borrow money from a lender and repay it from your business’s cash flow over time. Common cases for debt financing include opening a new location, purchasing equipment or inventory, covering operational costs, refinancing debt, or expanding a team.
Comparing Debt Financing Options
There are multiple borrowing avenues that fall under the debt financing umbrella. Depending on how long your cafe’s been in business, how much you’d like to borrow, and how much revenue your business generates, one type of financing may be more appropriate than another.
Option #1: Term loan
Best for: Established businesses making investments for growth
Term loans are one of the most common debt financing options. With a term loan, you borrow a specific amount of money and repay it over time. Term loans can feature terms of just a few months or extend up to five years.
Your interest rate may be fixed or variable. The rate you’ll pay depends on factors like your operating history, revenues and personal credit score. An online lender may be able to offer more favorable rates on a term loan compared to a traditional bank.
The amount you can borrow with a term loan may be anywhere from $20,000 to $1 million.
Option #2: Equipment loan
Best for: Newer businesses financing small and large-scale equipment purchases for your café or coffee shop
You can’t successfully run a café if your espresso machines or coolers are constantly on the fritz. An equipment loan can help you upgrade your existing equipment without tapping into your cash reserves.
Generally, equipment financing allows you to borrow up to 100% of the equipment’s value. The equipment acts as collateral for the loan. Depending on the loan amount and the lender, you may have to offer something in the way of a down payment.
The interest rates for equipment loans are slightly higher what you’d expect with a term loan. Funding speed is typically just as quick, with financing available in as little as two to three business days.
Option #3: Working capital loan
Best for: Newer and established business that need funding to cover day-to-day expenses
Working capital loans are designed to cover short-term business needs. For example, if you want to revamp your marketing campaign or stock up on inventory ahead of the holiday season, a working capital loan might be the answer.
These loans typically have lower borrowing amounts than term or equipment loans, often maxing out at $500,000. The interest rates for working capital loans may be higher, based on the lender and your creditworthiness.
Something else to consider about working capital loans is that they tend to have shorter repayment terms. Generally, these loans have terms of 12 months or less so you’ll need to consider whether that’s something your current cash flow can sustain.
Option #4: Merchant cash advance
Best for: Newer businesses or cafés, and coffee shop owners with less-than-perfect credit
If your café has steady debit and credit card sales, you may be able to borrow against them using a merchant cash advance. Merchant advances are repaid out of your future credit and debit receipts. This type of funding is fast and you don’t necessarily need excellent credit or a longer operating history to qualify.
In lieu of an interest rate, merchant cash advances use a factor rate, which often ranges from 1.15 to 1.5. While a merchant cash advance can offer convenience, it’s important to calculate what the true cost of borrowing is before pursuing this financing option.
Prior to making a final decision regarding financing for your café, it’s essential to weigh the pros and cons of each pathway. Ultimately, the option you choose should allow you to reach your business goals without compromising the stability of your bottom line.
—Samantha Novick is content manager at Bond Street, a small business blog designed to make business growth simple, transparent, and fair.