Differences Between Equity And Debt Financing

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Equity and Debt Financing
Every business wants to expand and grow in some form whether it is by purchasing new equipment or a new site for their business. When they decide to expand they usually have to decide on a type of financing. The two main types of financing for a business expansion are equity financing and debt financing. Equity financing is the selling of stock in the company whereas debt financing is incurring debt by taking out a loan with a lender. There are differences between equity and debt with the main one being with equity financing some control over the company is given up with the sale of stock in the company. Debt financing the owner/owners retain all control which is also a benefit. A benefit for equity is no debt is incurred
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If the funds to expand are not available internally by means of profits, then they look at their external options. The two main external options are equity financing and debt financing. Equity financing is the selling of shares of stock in the company. Equity financing “keeps management away from the hassles of raising funds again and again like other sources of financing viz. debt. Debt is raised and paid back over a period of time” (eFinance Management, n.d.). Some of the benefits of equity financing: Permanent source of financing enabling management to concentrate on the main goals of the company such as manufacturing the products that the customers want or providing the services that the customers want/need. No obligation to pay dividends or pay smaller dividends depending on the cash flow. Open chances for borrowing with the company being equity financed, “a bank or any other financial institutions require a company to invest roughly 20 to 25% by equity to finance other 75 to 80% debt” (eFinance Management, n.d.). Profits are retained by the company which maximizes shareholder’s wealth. Some disadvantages of equity financing: Giving up control of the company by the owner/owners by selling shares of stock in the company. Expected rate of return is higher, the more investors there are the higher the rate of return is expected as there is a higher risk of investment. The more investors there is …show more content…
“Debt financing occurs when a firm raises money for working capital or capital expenditures by selling bonds, bills or notes to individuals and/or institutional investors” (Investopedia, 2016). The main advantage of debt financing is the owner/owners retain all control of the company which is different from equity financing where some control of the company is given up to investors in the form of shares in the company. Another advantage of debt financing is once the debt is paid, the principle and interest, all profits are retained by the owner/owners. The interest on the principle is usually at a fixed rate so that the company will know how much interest is actually being paid on the principle. This is an advantage as the interest is tax deductible. A disadvantage of debt financing is if the company’s collateral / assets are not enough to cover the debt the lender might require a higher interest rate on the principle. Another disadvantage is “adding too much debt can increase the cost of capital, which reduces the present value of the company” (Investopedia,

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