Which one is best for your business/project?
When it comes to looking out for funding to support your new startup or enhance the growth of an existing brand you will always have to choose between debt funding or Equity.
The Question usually is Debt VS which is best for your business and why? The simple answer is that it depends. The equity versus debt decision relies on a large number of factors such as the current economic climate, the business’ existing capital structure, and the business’ life cycle stage, to name a few. In this article, we will explore the pros and cons of each, and explain which is best depending on the context.
According to small business concerns on findlaw.com the below are the advantages and disadvantages of debt to equity financing for your business
Advantages of Debt Compared to Equity
- Because the lender does not have a claim to equity in the business, debt does not dilute the owner’s ownership interest in the company.
- A lender is entitled only to repayment of the agreed-upon principal of the loan plus interest, and has no direct claim on future profits of the business. If the company is successful, the owners reap a larger portion of the rewards than they would if they had sold stock in the company to investors in order to finance the growth.
- Except in the case of variable rate loans, principal and interest obligations are known amounts which can be forecasted and planned for.
- Interest on the debt can be deducted on the company’s tax return, lowering the actual cost of the loan to the company.
- Raising debt capital is less complicated because the company is not required to comply with state and federal securities lawsand regulations.
- The company is not required to send periodic mailings to large numbers of investors, hold periodic meetings of shareholders, and seek the vote of shareholders before taking certain actions.
Disadvantages of Debt Compared to Equity
- Unlike equity, debt must at some point be repaid.
- Interest is a fixed cosit which raises the company’s break-even point. High interest costs during difficult financial periods can increase the risk of insolvency. Companies that are too highly leveraged (that have large amounts of debt as compared to equity) often find it difficult to grow because of the high cost of servicing the debt.
- Cash flow is required for both principal and interest payments and must be budgeted for. Most loans are not repayable in varying amounts over time based on the business cycles of the company.
- Debt instruments often contain restrictions on the company’s activities, preventing management from pursuing alternative financing options and non-core business opportunities.
- The larger a company’s debt-equity ratio, the more risky the company is considered by lenders and investors. Accordingly, a business is limited as to the amount of debt it can carry.
- The company is usually required to pledge assets of the company to the lender as collateral, and owners of the company are in some cases required to personally guarantee repayment of the loan.
Understanding the pros and cons of of your choice between debt and equity financing will help you make an informed decision on which way to go. If in doubt, Hire Us