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Debt Vs Equity: What’s The Difference?

Posted by in Debt
21
Aug 2017

When it comes to raising funds to start or grow a business, you can either leverage your assets or borrow the needed funds externally. Capital from your own sources can be in the form of equity, where you raise money by selling some of the company stock to shareholders, while borrowed funds refer to company debt that should be repaid, plus interest.

Debt Vs Equity: The Difference

Equity investment

This form of funding requires you to find equity investors to provide the capital in exchange for a stake in the business. The funders or investors take a calculated risk on the future of your business, and stand to profit from your success. Their willingness to fund your business shows their confidence in your ability to build a more valuable company.

Besides providing the necessary finance, equity investors also offer industry specific connections, expertise, and long-term support to running the venture.

Debt financing

This method of raising capital requires you to approach a lender such as a bank or other financial institution for a loan. Lenders typically evaluate your ability to repay the loan plus the interest. They must be certain that your business can make regular payments on time, usually right from when the loan is granted.

Lenders also require some form of security, and lack flexibility in their terms. This option is generally not recommended for young businesses that have uncertain cash flow, companies facing change, or organisations looking to fund a high-risk project.

Which finance option is right for your venture?

Here are some things to keep in mind:

  • Equity dilutes your ownership interest in your company, which means that you will have to share the profits for the life of the business. The lender, on the other hand, has no claim to business equity, and only requires you to repay the principal amount plus interest on time.
  • You can calculate the principal and interest obligations on a fixed rate loan, which makes it easier to forecast and plan. However, the monthly payments become a fixed business cost that raises the break-even point. Large payments can make it difficult to scale and increase the risk of insolvency unless you consider options such as debt consolidation.
  • With equity investment, the company is required to organise meetings of shareholders, send them periodic mailings, and seek a vote from the investors before taking action on certain matters.
  • Raising equity capital is quite complicated as your business needs to comply with national and provincial laws and regulations. But at least you will be able to maintain cash flow and re-invest more of the profits for faster growth.

There is no clear winner between debt and equity financing. Each option offers certain benefits that may be more attractive to certain types of businesses than others. Consider discussing your options with a professional before making any decisions.

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