Differences Between Debt & Equity Financing

Posted by transworldma on April 11th, 2022

Finding adequate financing can be a problem when one hopes to raise capital for a specific reason. Most small and medium companies may try to choose between debt & equity financing to solve the money-related issues. Although the purpose of these financing options is the same, there are considerable differences between the two. Most companies go forward by combing both types of financing, thus ensuring the advantages and tacking the cons in equal measure.

The uninitiated need a closer look at these financing types before favoring one or the other. In general, companies do have a choice when seeking finances. The ease of access and easy terms usually helps them to arrive at a decision. The debt-to-equity ratio also enables one to understand the extent of financing provided by debt and equity.

It is advisable to have all information available before opting for one or the other, though. Some of the facts that become a must-know when contemplating being financed include the following:

Equity Financing

This involves selling a part of the company\'s equity in exchange for capital. Sure, this is an easy way to raise capital as needed. The investor financing the company will have a say in the company\'s running. This may not be acceptable to every director of the board. It is thus essential to discuss the loopholes before going ahead and offering equity to the financer.

This kind of financing comes with a few advantages as well. There is no obligation for the borrower to repay the amount with interest. Sure, the said company would assure the investor of a good ROI but there is no legal obligation to repay the sum within a specific period. The absence of monthly payments helps the borrower use the amount as needed. The concerned company can choose to expand its operations or pay off some of the previous debts or even diversify as deemed fit by the owners and partners.

Unfortunately, there is a flipside included as well. While one would have to heed the words of the investor before making decisions, the company owner(s) would have to part with a significant amount of its profits too. The only accepted way of stopping such interference and monetary loss would be to buy the investor out. However, that possibility would be counterproductive as the sum for buying the investor out is likely to exceed the financing amount.

Debt Financing

This type of financing is akin to a loan, wherein the borrower would have to repay the debt with interest. However, one would have to check the terms & conditions carefully before agreeing to debt financing. The creditor may include specific terms that prevent a company from operating outside its primary business. The debt-to-equity here is low enough to please the creditors making such financing available readily.

The benefits of debt financing far exceed that of equity, but the consequences may not be conducive if the borrower fails to repay as required.

It would be advantageous to hire an experienced business financial advisor to ensure quick resolution of all economic issues.