Equity & Debt Financing

When embarking on a business endeavor besides the business idea one of the first questions you ask is about financing. Where do you get the needed cash for the new business idea ? thFGNW17GR

You have for a business financing mainly 2 options , debt or equity financing .

Debt financing implies that you get a loan from a financing institution. This debt financing option comes with advantages and also disadvantages.

Advantages of debt financing

  • you do not have to answer to anyone as a financing investor , you call all the shots
  • the interest paid for the loan is usually tax deductible , you lower your tax liability
  • you own all the profits , the lender has no share in your profits
  • costs of debt financing is usually lower than the equity financing

Disadvantages of debt financing

  • you have to pay your loan at fixed dates where you maybe need the available cash for other things. You might experience cash flow issues.
  • the interest and loan payments are mandatory, meaning that regardless of your profits you have to pay the loan and interests
  • you commit to certain loan and interest payments without knowing your future profits
  • usually you have to provide guarantees for your loans

DE1The equity financing implies that you invest your own money or money from investors in exchange for equity.

Advantages of equity financing

  • cash available can be used for financing of business activities , you do not have to consider loan and interest payments. All the available money can be used for productive activities.
  • your investors can support you in the development of your business
  • there is usually no money back guarantee if your business goes bust

Disadvantages of equity financing

  • when having equity investors in the company you can not call all the shots
  • the profit is shared with your investors
  • equity financing is usually associated with higher returns than loans

 

When talking about the financing of a business idea most companies go for a mixed financing solution . a debt – equity mix. Depending on the type of business and on the evolution stage you might have more debt or more equity.  Usually early stage businesses go for the more equity option whereas more developed businesses get also debt financing.

Depending on the industry and business type there is a optimal debt / equity ratio that you can use for financing. Do not forget that equity comes with a higher cost but with less risk. Debt is cheaper in terms of lone cost but is much riskier.

For more details related to this topic get in touch with TopCFO we are more than happy to support you.

 

 

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