What’s the Difference Between Equity Financing and Debt Financing

Financing is one of the primary challenges faced by businesses worldwide except for those who have amassed enough wealth to begin and grow their business. Well, If you find yourself seeking funding to satisfy your business needs but are confused about the financing option that would suit your business priorities then, this article is for you. In this article, you will learn the two types of financing options you can explore; equity financing and debt financing and also how you can conveniently secure either of them.

What is Equity Financing?

Equity financing is a type of financing option that requires the business owner or company to sell a portion of its company to an investor in return for money received. These fractions of ownership are often sold as shares through an initial public offering (IPO) listed by the company in a stock market.

Sources of Equity Financing

Below are the ways capital can be raised from equity financing;

  • Crowdfunding
  • Corporate investors
  • Venture Capitalist firms
  • Initial Public Offerings (IPO)
  • Angel investors etc.,

What is Debt Financing?

Debt financing is a type of financing option that works as a loan. In debt financing, a company borrows money from an investor with the agreement to pay interest on the amount and also to repay the exact sum of money received from the investor at a later date which is agreed upon by both parties(company and investor).

Sources of Debt Financing

  • Loans from banks, and investors
  • Personal loans from family, and peer to peer lending
  • Invoice factorization
  • Business lines of credit and credit cards
  • Small Business Administration(SBA) loans etc.,

The Difference between Equity Financing And Debt Financing

The difference between equity financing and debt financing lies within its approach to raising capital: Equity- Selling a portion of business ownership in return for capital received, debt- the borrowing of money with the agreement to pay interest and also repay the loan amount at a later interval.

Which one is the best?

The above question is the most commonly asked question about Equity financing and debt financing.

Truth is, there is none which is better than the other or less risky. That which is considered best amongst the two depends on the priorities of the company seeking the funding.

Companies that rely on control and ownership would not think equity financing to be a good choice because selling a portion of their ownership implies that the investor also makes decisions in the company going forward through the percentage he owns. Also, equity financing considers the payment of a percentage of the overall profits made by the company to the investor as dividends(because the investor co-owns the company), but many businesses do not think it to be fair.

Debt financing entails that the company pays interest to the investor for the loan amount and also repay the amount itself when due. This could lead to lots of money being spent in the process and these expenses can weigh heavily on the company if profitability is not at its highest. Because the company is legally obliged to make these payments, in the instance of bankruptcy or slow sales it could slow business growth and in most cases lead to asset loss( some debt financing requires collateral guaranty). However, once the principal and other outstanding payments have been made, the relationship between the business/company and the investor ceases.

Final Thoughts

Equity financing and debt financing are great financing options for companies who are looking for capital to grow or expand their operations. However, before choosing any as a means of securing funding it is important to consider the current profitability it will have to your business and how your business will be affected by the decision over time.

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