Equity Financing vs. Debt Financing

Debt financing and equity financing are two different types of financing that are available to businesses. The terms may be relatively new, but they come from old and tried concepts.

In short, debt financing is a loan. You borrow money from a lender with the agreement that you will pay it back in a certain amount of time. The interest accrued is tax deductible. As implied by its name, you have a "debt" with this financing method. The lender does not have any power over your business. You maintain a relationship until you repay the amount. Debt financing can be a short-term or long-term process. Lenders of business loans are banks and the SBA (Small Business Administration). This type of financing can be a disadvantage if you do not have the revenue to pay it back. Further, accumulating debt makes businesses unattractive to investors.

Equity financing, on the other hand, does not involve debt. It is the exchange of money from a lender for a part of ownership in the business. Venture capitalists and angel investors deal with equity financing. The traditional means of repayment do not apply in this situation. The lenders will be repaid if your business makes money. With this type of financing, a business owner can lose autonomy and control over the company. Investors have a say in the functions and decisions.

If a banker, angel investor, or venture capitalist is thinking about providing funds to you, they will consider your debt to equity ratio, which is the debt amount you have compared to the equity amount. This shows the amount of money that is available for repayment in the face of default. The ratio also shows if the business is run sensibly.