Debt & Equity Financing Explained!

Posted by transworldma on November 15th, 2022

Every company, irrespective of its size, needs to think of financing. Sure, a business cannot afford to remain stagnant and may require funding for expansion. On the other hand, small companies on the verge of bankruptcy may try to improve their funds by opting for a suitable financing plan. It is essential to understand that almost all companies consider choosing between debt & equity financing when in urgent need of funding.

The first option i.e, debt financing, is self-explanatory. The company can consider borrowing a specific sum from a lender and then repaying it with interest. It can be regarded as a loan, however. Debt financing is only sometimes unconditional. The terms may include restrictions on the said company that prevent it from experimenting with its core business. Opportunities may be lost due to this limitation, however. Having a low debt-to-equity ratio is an advantage that makes lenders think favorably about providing an additional loan to the company as debt financing.

Well, accepting debt financing comes with several pluses. The company may be tempted to accept it due to the following:-

The company continues to enjoy its operations without risking the ownership

· The lender cannot claim a percentage f the profits

· Repayment of loan must be done according to specific terms and is predictable.

· The interest is tax-deductible

· There are multiple options for providing collateral to secure the loan.

· Repayment options are varied

Equity financing, on the other hand, concerns selling the company’s equity in exchange for capital! The ender has a share of the company and participates in business operations. However, there is no requirement for repayment or giving an additional sum as interest. The only downside here is giving up a part of the ownership. There are many advantages experienced here as well. The one’s considering such financing are pleased to note the following:-

· No payment of dividends on equity

· The new members may bring meaningful connections and industry experience to the table

· No repayment of the finances obtained

· A rise in business credentials

Well, there is no right or wrong decision here. A company would have to consider its best interests before arranging for financing.

Financing Considerations

Obtaining equity financing can be simpler with not much formality involved. The concerned company must be seen as attractive to the creditor with the financial projections looking good. However, the company owner/partners must be willing to give away some shares to the lender along with a substantial amount of control too.

A company that hopes to profit in the future may not be willing to part with the control. Debt financing will seem a better proposition for them. However, they should have other assets that can be used as collateral. The ability to repay the debt is a criterion that must be examined closely before signing the documents.

The company owner cannot consider every aspect and continue with the day-to-day tasks effectively. It is advisable to seek the assistance of an experienced business financial advisor or a firm to make the right decision.