Debt and Equity Financing

Debt and Equity Financing

Lauren Rolston

Rasmussen College

Author Note

        This research is being submitted on December 17, 2014, for Lisa Hoggarth’s B361/ENT3624 Section 01 Funding a New Business course by Lauren Rolston.

Debt and Equity Financing

In business it is often necessary for the owners to tap into financial resources. There are a variety of financing resources they can utilize. They are broken into two categories. These are debt financing and equity financing (Thomson Reuters, 2014). Each one has its advantages and disadvantages. An entrepreneur should know the pros and cons of each one. That way she can make educated decisions about her business.

Equity Financing

     Equity financing involves bringing in investors or partners. These people will provide your business with capital. This is exchanged for partial ownership of the business. Their expectation is that the business will become successful and they will make a profit. The advantages to equity financing:

• You don't have to pay it back so there is less risk than a loan.
• An option for a business that cannot afford to take on debt.
• It can add credibility to your business by being tapped into the investor's network.
• The investors are looking at the long term plan and do not expect an immediate return on their investment.
• Profits do not have to go toward a loan payment.
• There will be more cash available to expand the business.
• If the business fails, you do not have to pay back the investment (National Federation of Independent Business, 2014).

While these advantages are very nice and make equity financing sound like a great idea, there are also these disadvantages:

• The returns can be more than the rate you would pay for a loan.
• The investor will be entitled to a percentage of the profits.
• You will be giving up some control as the investor will require some ownership of your business.
• You will have to consult with investors before making decisions -- and you may not agree with her.
• If the differences become irreconcilable, you might have to cash in part of your business and let the investors run the company without you. 
• It takes time, research, and effort to locate the right investors for your company (National Federation of Independent Business, 2014).

Debt Financing

    Debt financing is a lot different than equity financing. For one thing the business relationship with a bank is different from an investor.  It does not require you to give up part of your company. However, taking on a large amount of debt, can prevent growth(Thomson Reuters, 2014). The advantages are:

• The lender does not have a say in the way you run your company
• The lender does not have any ownership in your business.
• The business relationship is over after  the loan is paid off
• Loan interest is tax deductible.
• You can take out a short term or long term loan.
• You can plan your budget because the principal and interest are known figures (National Federation of Independent Business, 2014).

These are also great advantages. However, as with equity financing, there are disadvantages to debt financing such as:

• You have a specific amount of time in which to pay back the loan.
• Too much debt can cause cash flow problems which will make it harder to pay it back.
• Carrying too much debt causes you to be seen as "high risk" by potential investors. This will limit your ability to get capital through equity financing in the future.
• The business can be left vulnerable during difficult times when sales are down.
• Debt makes it harder for a business to grow due to the high cost of repaying the loan.
• Business assets may be held as collateral by the lender.
• The owner is usually required to personally guarantee loan repayment (National Federation of Independent Business, 2014).

    I would prefer to go with debt financing. I believe it is the best route. One reason for that is that you do not have to give up any control to an investor. That would bother me a great deal. Just because they have money to invest does not necessarily mean they know what is best for my company. I work better independently and not with someone watching over my shoulder. A bank does not care what you do as long as you make your payments on time.