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Debt vs Equity
If small businesses are in need of additional capital, taking out a business loan or looking for an investor is a necessary decision. The choices you make when deciding how to finance your business can last a lifetime. This is why you want to do your research before spending any large amount of money. Whether for personal use or professional use. With vast resources on the internet, it’s easy to learn about the differences between debt and equity financing. Below, you will read the pros and cons of debt vs equity.
Debt vs Equity Definition
Debt Financing –
When you borrow money from a lender that will be paid back over time. Like other forms of lending money, there will be interest accrued. If an individual has taken out a loan, they have financed something with debt. Examples of debt financing are term loans, credit cards, invoice or receivables financing, or merchant cash advance.
Equity Financing –
When you sell a percentage of your business to venture capitalists or investors in exchange for the use of their capital. This type of financing works well for business startups and companies who want to grow but don’t have the money to do so. Examples of equity financing are angel investors, venture capitalists, or other small investors.
Debt vs Equity Financing Pros and Cons
Pros of Debt Financing
- You’re in control of the capital.
- There’s no profit sharing.
- A wide range of business loans and repayments.
Pros of Equity Financing
- Investors take on most of the risk.
- If the business fails, there are no payback investments.
- There’s more cash to grow your business.
Cons of Debt Financing
- It can be difficult to qualify for certain loans.
- If the business fails, it could cost your assets.
- Required repayment despite your success.
Cons of Equity Financing
- You’re giving away a percentage of your business.
- May disagree with investors over matters.
- The process can take a long time.
Difference Between Equity Financing and Debt Financing
There are many differences between debt and equity financing. Debt is a more affordable form of financing since it saves on taxes, but equity is considered the convenient method of financing for businesses. Debt holders have no ownership of the company while the equity shareholders have a percentage of the company. Another important aspect of equity financing is that the shareholders have voting rights and could make consequential decisions for the company.
Whereas, debt holders have no voting rights for the company in question. With pros and cons for both forms of outside financing, a small business has to decide what is right for them. Depending on the amount of money you need and the amount of outside involvement you are okay with, make this decision carefully.
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