Debt vs. Equity Financing
Equity is the worth of an asset minus the total of all liabilities on that asset.
Equity Financing is the course of increasing capital by the sale of shares in a business. Equity financing has a broad spectrum to increase ownership shares, including asking friends and family members to invest funds and receive ownership shares accordingly. Large initial public offerings can be made to raise funds from millions to billions. Similarly, financing from other private companies can be considered in equity financing. Equity financing is different from debt financing because debt financing occurs when money is borrowed and must be paid back, usually with interests.
Debt is the money borrowed by an entrepreneur to fund a business that he or she could not afford under normal conditions. A debt arrangement means that the borrower is given money under the condition that borrowed money will be paid back at a later date, usually with interest. There can be different types of loans, and debt can be issued either to an individual borrower or a business.
In some instances, borrowing money is much better than giving up equity.
Reasons Why Borrowing Money Is Better Than Giving Up Equity
1. When borrowing money and incurring debt, the lender has no claim to equity in the business.
Ownership remains the same. Business operations and bookkeeping decisions remain with the owners, entrepreneurs, and executive management. Equity financing changes your business ownership structure and equity because new shareholders and managers are introduced into the company through their purchased shares.
2. When net profit increases, the lender will only be repaid the borrowed money, and the interest is accrued. If business progress and rewards are larger, only the entrepreneurs will reap the rewards. The lender will have no claim or share in the business rewards and profits. However, if you utilize equity financing, the shareholders can claim their share in net profits. In short, future profits will be distributed among equity holders, and your profit share will be reduced inequity funded situations.
3. Interests on debt can be subtracted on the business’s tax returns. Borrowing money can be a gift to entrepreneurs. The cost of interest decreases the taxable profit that your business earns. Thus it reduces the tax expense in your company. Large corporations and businesses also use this strategy to reduce tax expenses. If you get cash from equity instead of debt, you will pay off the money to the equity holder for your business. Conversely, when debt is taken, the interests are deducted from the taxable profit, the expense of interests is reduced, and the debt will also be paid back eventually.
4. When debt is taken, there will be no need to seek the vote of shareholders in the business for making certain decisions. Debt is good if you want to keep the business and the whole ownership with you. In the case of equity financing, the shareholder’s vote will be compulsory in making decisions for the growth of the business, investments, expenses, and other internal decisions.
5. Debt boosts discipline, and discipline ensures success. Debt often results in disciplined spending and reduces unnecessary expenses within the company. Debt is not merely taken to increase discipline, but it is also advantageous in reducing unnecessary expenses in the business because the debt must be repaid from revenue. Similarly, debt promotes a checks-and-balance system to be maintained in business bookkeeping, cash flow is regularly matched with financial statements and balance sheets, and business operation reviews are routinely done.
Conclusion
It is a myth that debt is never good in any kind of business or situation. Many times, debt is proven to be a better option than giving up equity or ownership. Debt can be paid back, but once equity is relinquished, the other shareholders in the company must be consulted or involved.
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