Debt Financing and Equity Financing help in raising the capital for the business development needs. Debt Financing is the borrowing of money for business needs, whereas Equity Finance is all about selling a portion of the equity of the business or the organization.
There are few companies and organizations that use the combination of Debt and Equity Financing to grow their business.
Key Takeaways
- Debt financing involves borrowing money to fund a business, which must be repaid with interest.
- Equity financing involves raising funds by selling shares or ownership stakes in a company.
- Debt financing offers the advantage of maintaining full business control, while equity financing reduces financial risk but dilutes ownership.
Debt Financing vs Equity Financing
Debt financing is when a company borrows money to be paid back in the future with interest, and it is observed in the case of car loans, student loans and businesses. Equity financing is when companies sell shares to investors to increase capital. It is done with equity crowdfunding and private equity firms.
Debt Financing is observed in the case of car loans and student loans, where the money is provided as a lump sum and then repaid gradually with an agreed amount of interest upon it.
Debt financing is suitable if, for a business, there is one sole owner who is borrowing the capital through debt financing. If the company is expecting a short-term relationship with the financing source, then debt financing would be a great option.
Equity Financing enables us to raise capital by selling shares in the business. There are various sourcing platforms through which the shares can be sold, and capital can be raised.
Private equity firms and Equity crowdfunding platforms are such investors through which we can sell the shares of the business or the company and raise capital.
Comparison Table
| Parameters Of Comparison | Debt Financing | Equity Financing |
|---|---|---|
| Definition | Debt Financing is borrowing money in the form of a lump sum amount to raise the capital of the business. | Equity Financing is raising the capital of the company by selling shares through various investors and investing platforms. |
| Security | Debt Financing asks from the borrower collateral such as assets that would be claimed when the borrowed money is not repaid. | Equity Financing does not ask for any forms of collateral. |
| Repayment | Debt Financing would be asking the borrower to repay the amount borrowed along with the interest rate inquired in specified installments. | Equity Financing has no repayment obligations and the business would be grown through selling shares. |
| Ownership | Debt Financing lays the full ownership over the person accessing the financial services provided. | Equity Financing does not lay the full ownership because a part of the equity has been sold and it is been shared as well. |
| Prerequisites | Debt Financing requires a consistent cash flow, a proven business model, a borrower should be the sole owner of the business, a short-term relationship with the financial service, and sufficient enough to manage the cash flow. | Equity Financing requires a limited financial history, lack of collateral is also fine, no burden of regular loan repayments, business growth plans, expanding operations, and moving into new markets for expanding the business. |
What is Debt Financing?
Debt Financing involves the borrowing of money and repaying it with the interest proposed while borrowing to raise the capital of the business.
Certain restrictions prevent the company from taking advantage of the business’s core activities. There are numerous advantages to debt financing as well.
Debt Financing does not have control over the business as the relationship ends when the borrowed amount is repaid along with the proposed interest.
Loan repayments do not fluctuate, and the interest paid is tax-deductible. Debt is an expense that needs to be paid regularly in regular instalments within the proposed time.
Debt Financing requires security that ensures and provides security for the amount being provided. The security might be in the form of assets or collateral.
Sometimes, it is necessary to link the security with the family’s financial history to ensure the amount will be repaid as well. It also sees a consistent cash flow.
Debt Financing requires sole ownership of the business to be run by the borrower. For a start-up with no physical assets and financial history, one might find it difficult to acquire Debt Financing.
In Debt Financing, the lender does not have any rights over the business development process, which is not in the case of other financial services.
What is Equity Financing?
Equity Financing involves the selling of a portion of its shares or equity in return for capital to develop the business and its growth.
There are no repayment obligations in the case of Equity Financing as they are not borrowed but an exchange of selling the shares. But in Equity Financing, the lender gets the rights over the shares bought by the lender.
Equity Financing requires no collateral or asset as security. They are required to share the return for the share sold and for which the capital has been obtained by selling the share to the investor.
In the case of ownership, in Equity Financing the lender shares the ownership as well. A start-up with a good business plan would get Equity Financing investors as well.
Equity Financing requires time to find the best and right investor for the right business. It has a long process to be followed that involves terms and conditions to deal with as there is a share of equity being sold.
It involves a lot of legal procedures and a due diligence process that helps in getting the business right on its track to success.
Equity Financing requires a good and right investor for the business. It also has a few prerequisites from the borrowers’ side, such as a good business growth model, the ability to manage business fluctuations, moving into new markets and hurdles, and expanding the business operations as per the requirement.
Main Differences Between Debt Financing And Equity Financing
- Debt Financing is borrowing a lump sum of the amount that needs to be repaid along with the interest within a specified period of time, whereas Equity Financing involves selling the equity of the company in return for the capital.
- Debt Financing involves proposing collateral or assets for the security, whereas Equity Financing Does not involve any security as the shares are bought in exchange for the capital.
- Debt Financing requires a good financial history and sole ownership of the business, whereas Equity Financing requires a good business growth model and the ability to move into the new market.
- Debt Financing has repayment obligations that are seen as an expense that limits the company’s profit as well, whereas Equity Financing has no repayment obligations and burden over the company’s profit.
- Debt Financing claims the assets or collateral submitted as security if the loan borrowed is not repaid within the specified time, whereas Equity Financing does not have such issues as a burden.
- https://www.sciencedirect.com/science/article/pii/S0378426686800280
- https://link.springer.com/chapter/10.1007/0-387-24519-7_12
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Absolutely, it’s essential to weigh the pros and cons of each type of financing to make the best decision for a business’s needs.
I found the section on equity financing particularly enlightening, shedding light on the complexities of selling shares and obtaining capital. This is an insightful piece of writing.
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This article offers a comprehensive look at debt and equity financing, but it could use more emphasis on the potential risks associated with each type of financing.
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