Equity Financing vs. Debt Financing: A🐠n Overview

To raise capital for busine🥂ss needs, companies primarily have two types of financing as an option: equity financiꦇng and debt financing.

Most companies use a combination of debt financing and equity financing, but there are some distinct advantages to both. Principal among them is that equity financing carries no repayment obligation and provides extra 澳洲幸运5官方开奖结果体彩网:working capital that can be used to grow a business. 澳洲幸运5官方开奖结果体彩网:Debt financing, on the other han♑d, does not require giving up a port🥂ion of ownership.

Companies usually have a choice as to whether to seek debt financing or equity financing. The choice often depends upon which source of funding is most easily accessible for the company, its 澳洲幸运5官方开奖结果体彩网:cash flow, and how important maintaining control of the company is to its principal owners. The 澳洲幸运5官方开奖结果体彩网:debt-to-equity (D/E) ratio shows how much of a company’s fina꧂ncing is proportionately provided 🍒by debt and equity.

Equity Financing

Equity financing involves selling a portion of a company’s equity in return for capital. For example, the owner of Company ABC might need to raise capital to fund business expansion. The owner decides to give up 10% of ownership in the company and sell it to an investor in return for capital. That investor now owns 10% of the company and has a voice in all business decisions going forwar🃏d.

The main advantage of equity financing is that there is no obligation to repay the money acquired through it. Of course, a company’s owners want it to be successful and provide the equity investors wi♍th a good return on their investment, but without required payments or interest charges, as is the case with debt💙 financing.

Equity financing places no additional financial burden on the company. Since there are no required monthly payments associated with equity financing, the company has more 澳洲幸运5官方开奖结果体彩网:capital available to invest in growing the business.

But that doesn’t mean there’s no downside to equity financing. In fact, the downside is quite large. To gain funding, you will have to give the investor꧂ a percentage of your company. You will have to share your profits and consult with your new partners anytime you make decisions affecting the company. The only way to remove investors is to buy them out, but that will lik𝓡ely be more expensive than the money they originally gave you.

Debt Financing

Debt financing involves borrowing money and paying it back with interest. The most common form of debt financing is a loan. Debt financing sometimes comes with 澳洲幸运5官方开奖结果体彩网:restr🍸ictions on the company’s activities that may prevent it from taking advantage of opportunities outside the realm of its core business. 澳洲幸运5官方开奖结果体彩网:Creditors look favorabꦬly upon a ꧙relatively low debt-to-equity (D/E) ratio, which benefits the company if it needs to access additional debt financing in the future.

The advantages of debt financing are numerous. First, the lender has no control over your business. Once you pay the loan back, your relationship with the financier ends. Next, the interest you pay is 澳洲幸运5官方开奖结果体彩网:tax deductible. Finall✤y, it is easy to forecast expenses because loan payments do not fluctuate.

What if your company hits hard times or the economy, once again, experiences a meltdown? What if your business does not grow as fast or as well as you expected? Debt is an expense, and you have to pay expenses on a regular 🅷schedule. This co𒀰uld put a damper on your company’s ability to grow.

Finally, although you may be a 澳洲幸运5官方开奖结果体彩网:limited liability company (LLC) or other business entity that provides some separation between the company and personal funds, the lender may still require you to guarantee the loan with your family’s financial assets. If you think debt financing is right for you, the U.S. 澳ꦉ洲幸运5官方开奖结果体彩网:Small Business Administration (SBA) works with select banks to offer a 澳洲幸运5官方开奖结果体彩网:guaranteed loan program that makes it easier for small businesses to secure funding.

Different Sources of Financing

Choosing which one works for you depends on several factors, such as your current 澳洲幸运5官方开奖结果体彩网:profitability, future profitability, reliance on ownership and control, and whether you can qualify for one or the other. The different types and sources for each type of financing are described in more detail 🍨below.

Equity Financing

Some sources of equity financing are:

• 澳洲幸运5官方开奖结果体彩网:Angel investors
• 澳洲幸运5官方开奖结果体彩网:Crowdfunding
• 澳洲幸运5官方开奖结果体彩网:Venture capital firms
• Corporate investors
• Listing on an exchange with an 澳洲幸运5官方开奖结果体彩网:initial public offering (IPO)

Securing equity financing can be simpler than debt financing, but you need to have an extremely attractive product or financial projections, as well as being able to surrender a portion of your company and often a good amount of control.

Debt Financing

Some sources of debt financing are:

• 澳洲幸运5官方开奖结果体彩网:Term loans
• Business 澳洲幸运5官方开奖结果体彩网:lines of credit
• 澳洲幸运5官方开奖结果体彩网:Invoice factoring
• 澳洲幸运5官方开奖结果体彩网:Business credit cards
• Personal loans, usually from 澳洲幸运5官方开奖结果体彩网:family or a friend
• 澳洲幸运5官方开奖结果体彩网:Peer-to-peer (P2P) lending services
• 澳洲幸运5官方开奖结果体彩网:SBA loans

The ability to secure debt financing is largely based on your existing 澳洲幸运5官方开奖结果体彩网:financials and 澳洲幸运5官方开奖结果体彩网:creditworthiness.

Equity Financing vs. Debt Financing: Example

Company ABC is looking to expand its business by building new factories and purchasing new equipment. It determines that it needs to ra🦄ise $50 million in capital to fund its growth.

To obtain this capital, Company ABC decides iꦉt will do so through a combination of equity financing and debt financing. For the equity financing component, it sells a 15% equity stake in its business to a private investor in return for $20 million in capital. For the debt financing component, it obtains a business loan from a bank for $30 million, wi🍸th an interest rate of 3%. The loan must be paid back in three years.

There could be many different combinations with the above example that would result in different outcomes. For example, if Company ABC decided to raise capital with just equity financing, the owners would have to give up more ownership, reducing its share of future profits and decision-making power. Conversely, if Company ABC decided to use only debt financing, its monthly expenses would be higher, leaving less cash on hand to use for other purposes, as well as a larger debt burden that it would have to pay back with interest.

Businesses must determine which option or combination is best for them.

The Bottom Line

Debt financing and equity financing are ways that businesses acquire necessary funding. Which one you need depends on your business goals, 澳洲幸运5官方开奖结果体彩网:tolerance for risk, and need for control. Many businesses in the startup stage will pursue equity financing, while those already established and those that have no problem with debt and possess a strong 澳洲幸运5官方开奖结果体彩网:credit score might pursue traditional debt financing types like smallꦫ business loans.