Equity vs. Debt Financing
Business owners constantly have to decide how to finance their expansion and operations of the business. Entrepreneurs have to choose whether to borrow more money through debt financing or seek outside investors through equity financing? Many factors influence the path each business takes, including the amount of debt a business already has, its cash flows, and the owner’s willingness to work with partners, among others.
Equity Financing
Equity financing involves an entrepreneur selling a part of their business’ equity in exchange for capital. It does not have an obligation to repay the money, unlike debt financing, and does not add any financial burden to a company.
Advantages
- Reduced risk factor
- Better cash flow
- Allows for long-term planning
- Offers better terms
Disadvantages
- Entrepreneur gives up some control
- Higher chances of conflict
- Potentially higher costs
Debt Financing
Debt financing involves borrowing the funding your business needs from lenders and paying back the principal with interest. Loans are the most common type of debt financing. A low debt-to-equity ratio allows a business to seek additional debt financing in the future if necessary.
Advantages
- You retain total control of your business
- Loan interest is tax-deductible, unlike shareholder dividends
- Predictability with the principal and interest payments predetermined.
Disadvantages
- Requires assets as collateral
- The business owner must have good credit ratings to qualify
- Requires fixed payments and drops in sales can affect repayment
- Debts affect cash flow, and having too much debts reduces your debt-equity ratio increases the risk of non-payment
