Financing means collection or raising of fund for a corporation or any other type of business organization.
It is usually two types: Debt Financing and Equity Financing.
Debt Financing
Debt financing means borrowing money that is to be repaid over a period of time, usually with interest. Debt financing can be either short-term (full repayment due in less than one year) or long-term (repayment due over more than one year.
In smaller businesses, personal guarantees are likely to be required on most debt instruments; commercial debt financing thereby becomes synonymous with personal debt financing. A type of Financing through the selling of a debt instrument is called Debt Financing.
Advantages of Debt Financing
The biggest advantage of debt financing is that the lending party does not gain any part of ownership of the business and the only obligation of business to lending party is to repay the debt.
Also, repayment of the loan is typically a fixed expense, according the terms of the loan.
Disadvantages of Debt Financing
The biggest dis-advantage is that the business will not have all of its cash flow available to do business.
Also, the interest that is owed can be high.
Equity Financing
Raising money for company activities by selling common or preferred stock to individual or institutional investors.
Equity financing describes an exchange of money for a share of business ownership. This form of financing allows you to obtain funds without incurring debt; in other words, without having to repay a specific amount of money at any particular time.
Advantages of Equity Financing
The major advantage of equity financing is that the cash flow that would have been used to repay the loan, can be used to grow the business.
Disadvantages of Equity Financing
The major disadvantage to equity financing is the dilution of shareholders ownership interests and the possible loss of control that may accompany a sharing of ownership with additional investors.
Differences between Debt Financing and Equity Financing
There are lots of differences between debt financing and equity financing.
|
Debt Financing vs Equity Financing |
|
|
Debt Financing |
Equity Financing |
|
Must be repaid or refinanced. |
Can usually be kept permanently. |
|
Requires regular interest payments. Company must generate cash flow to pay. |
No payment requirements. May receive dividends, but only out of retained earnings. |
|
Collateral assets must usually be available |
No collateral required |
|
Debt providers are conservative |
Equity providers are aggressive. |
|
Interest payments are tax deductible. |
Dividend payments are not tax deductible. |
|
Debt has little or no impact on control of the company. |
Equity requires shared control of the company and may impose restrictions. |
|
Debt holders cannot share any upside or profits |
Shareholders can share any upside or profits |
|
Does not grant ownership of the firm. |
Grants ownership of the firm. |
Raising of fund through debt financing is refundable. But Raising of fund through equity financing is nonrefundable.
Debtholder cannot participate in the management. But equity holder can participate in the management.
