Debt and Equity Financing Compared

When it comes to debt and equity financing, it's wise to know that a business loan provides a business owner with numerous advantages.

Equity Financing Definition

In a choice between debt and equity financing, many business owners opt for the quick and relatively easy equity financing. Basically, equity finance is any form of financing that does not incur debt. Business owners may not need to take out a loan if they have investors willing to put up money in exchange for a piece of the business. These investors may include family and/or friends, or come from a venture capital company. Venture capitalists are always looking for businesses with growth potential - and thereby increase their own profits.

Equity Financing Advantages

Advantages of equity financing include the following:

  • start-up costs are free and clear of a large debt burden to a bank or commercial loan lender
  • cash flow that would have gone to repay loans can go back into growing the business instead
  • with a business prospectus to your investors that rigorously outlines risks, your investors will know that if your business fails, they won't see their money back
  • some of your investors may have expertise or business acumen that they'll share with you, thereby helping your business to grow.

Debt and Equity Financing: Debt Financing

Debt and equity financing choices can be tough, but when your business needs money for start-up costs or to grow, you may find debt financing to be a better option.

Debt Financing Definition

In debt finance, you take out a loan for your business that must be repaid. The loan can be from a bank or commercial loan lender, the Small Business Administration (SBA) or other entity. Term of loan financing is generally one year or less for loans up to $100,000, and one year or more for loans above $100,000.

Advantages of Debt Financing

No question about the biggest advantage of debt financing: you own and manage your own business and don't have to share any of the profits. But there are other advantages as well.

  • Potentially better interest rate and lower repayment terms for your business loan
  • Control of your company business and ownership of all profit remains in your hands
  • Interest on the debt finance is tax deductible
  • Those who lend you money do not get a share of your profits, but you do have to make payments on time
  • SBA loans may offer better terms for small business loan financing than commercial loan lenders

Debt and Equity Financing: Which to Choose?

The decision depends on the type of business you own or plan to start, how much capital you have readily available to you that you can use, number and type of potential investors (such as friends and/or family, angel investors, venture capitalists), your tax situation and the tax situation of your investors.

Don't forget that debt financing, if not paid back in a timely fashion, can ruin your credit. Business loans secured with a personal guaranty will cause you to lose those assets if your business fails. And some of the interest rates can be very high, particularly for riskier ventures.

If you borrow money from friends or family and your business goes under, your relationships can become strained. They'll also be sharing profits from your business, and you could be hit with a lawsuit if they don't believe you're acting in their best interests (as investors).