Debt Financing vs Equity Financing

Debt Financing VS Equity Financing

Jim Stewart

ACC/400

Fredrick Thull

November 19, 2013

Debt Financing VS Equity Financing

When a business wants to expand, business owners must select the method of financing it feels is most beneficial to the company. Business owners have a variety of financing resources to choose from. Generally financing is broken into two categories, debt and equity. Debt involves borrowing money to be repaid, with interest. Equity involves raising money by selling interests in the company. ("Find Law", 2013)

Debt financing is the process of securing loans that must be repaid over time, usually with interest. Businesses can borrow money over the short term, or gain a short term liability that will be repaid within one year or a long term liability which the term would be for a period of over one year. The main sources of debt financing are banks and government agencies, such as the Small Business Administration (SBA). Debt financing can be attractive to the business owner because of tax advantages, because the interest paid on loans is generally deductible. Borrowing also limits future obligations of the business repayment of the loan, because the lender does not receive an ownership share in the business. ("Reference For Business", 2013)

However, debt financing also has disadvantages. New businesses sometimes suffer cash flow problems that make it difficult to make regular loan payments. Debt financing can cause businesses to be more vulnerable to economic downturns or rising interest rates. Carrying too much debt is seen as an increase in the perceived risk associated with the business, making it unattractive to investors and thus reducing the ability to raise additional capital in the future.

("Reference For Business", 2013)

For a large company a form of debt financing would be selling bonds to finance a new factory or new equipment. Another example of debt financing would be securing a bank loan or mortgage for the...