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August 23, 2016

DEBT FINANCING VS EQUITY FINANCING - ADVANTAGES AND DISADVANTAGES

What are the differences between debt financing and equity financing, and which is right for you? Our Corporate Director Matt Sutton, shares his expertise on this topic.

Deciding how to finance your startup is a key decision that can have huge consequences. The main question for many start-ups is whether to loan the funds or surrender equity in the business. Below are some of the main things to consider helping you make this important decision.

What is debt financing?

Debt financing is when you borrow cash from a lender with the intent of paying them back. The loan is given at a cost, in the form of interest, which acts as the motivation to the lender to provide the funds in the first place. 

Advantages

The lender will have no say in the way you run your business and does not own any of the company.

You are in control of how the money is used. There are sometimes constraints but generally, what you are using the financing for is up to you.

Once the loan repayments are finished, the business connection ends.

You have to pay the lender back the loan amount plus interest; but they will have no direct claim on future profits of the company.

Disadvantages

The debt must be repaid in full with interest within a fixed period.

The larger a business's debt, the more risky the business is considered by others. This may restrict the ability of the business to raise capital by equity financing in future.

Cash flow is compulsory for both the repayment of the loan amount and interest payments and must be accounted for.

What is Equity Financing?

In return for cash investment, the investor would receive a share of your company.

Advantages of Equity Financing

  • If your company fails, you are not required to pay back investments.
  • Investors may have knowledge, experience and connections to help you expand your business, adding more integrity and building deeper connections.
  • You will not have to use income to pay accrued interest and pay off the loan repayments as with debt financing. This means you have got more cash available to grow your company.

Disadvantages of Equity Financing

You may lose a degree of control of your business as the investor will acquire shares in the business and be entitled to a percentage of the profits where dividends are confirmed.

Decisions may have to be reviewed with and approved by the investors, which again, limits the control you have over your company.

Finding the right financier can take time. The process for debt financing is generally much faster.

There are many factors to study when making this choice and which option suits you best will depend on your business's credit standing, business plan and cash available, among others things. Many companies even use a mixture of both types of financing utilizing each to its best advantage.

The Corporate Team at Greenaway Scott is highly skilled in advising clients on the legalities of all types of debt, equity and mezzanine finance. For further info, please contact the corporate team by emailing corporate@greenawayscott.com.

The article was first published via Business Insider. Read the full article here.

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