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Introduction:
Financing is one way to find the monetary resources needed to achieve a specified project; it makes an outstanding contribution to enterprises development. Fund is also investing, in other words, it is the allocation of sums of money to complete the acquisition of durable goods or shares of a certain company that represent the capital of this same organization granted by the providers of capital. There are different types of financing that an entrepreneur can choose from in order to fund a new business. All such options are categorized, accordingly, into two groups: Debt financing and Equity financing, Both of which have benefits and disadvantages for the entrepreneur. When choosing debt financing for a new business, entrepreneurs are simply acquiring a loan from a lending institution or government agency, such as the Small Business Administration. When they decide to choose equity financing to fund their venture, they are simply exchanging the amount of capital for a piece of ownership in the business.

Difference between Debt and Equity Financing:

Debt Financing Debt financing refers to any Definition borrowed money which the

Equity Financing Equity financing is money lent in

3 exchange for ownership in a company.

entrepreneur must pay back to the New businesses can use equity financing lending institution. It can come in for their startups or when they need to the form of a loan, line of credit, rate and other terms apply. Who depends on Companies which are wellthis type of capital? steady sales, solid collateral, and profitable growth often rely on debt capital for financing their Where can I funding? businesses. Commercial banks Business Administration (SBA) raise additional equity capital to offset bond, or even an IOU. An interest existing debt. Companies with a more conventional profitability, and/or poor credit ratings often rely on equity capital for their funding needs. Personal Friends and family Investment banking firms Insurance companies Debt-to-equity ratio Requirements High Borrowers must show potential lenders they are willing to invest money in the business by using their own money. Application process A formal application must be filled out either in person at the lending institution of choice or online. Credit check Large corporations Low Good-standing credit history Borrowers must demonstrate their company is in a high-growth industry and there is a potential to produce a large return on investment An application and other pertinent materials are required for angel investors and venture capitalists. Family and friends usually do not require an application

established and have demonstrated approach to management, high

obtain this type of Loans through the Small

process. The higher the credit scores of the Family and friends usually do not company owner(s), the better the chance in obtaining a loan. conduct a credit check.

Term options

Short-term debt financing: total less than one year. Long-term: total repayment of

Usually, both angel investors and venture for an average of 3-7 years.

repayment of borrowed capital in capitalists are involved in an investment

Other

borrowed capital in over one year. A type of long-term debt Companies can also opt to obtain equity financing payment is a balloon payment, whereby the end of the term the lender and borrower financing by selling company stock to employees, Employee Stock Ownership Plan (ESOP), sharing control of the

Equity Financing:
You may have some cash you want to put into the business yourself, so that will be your initial base. Maybe you also have family or friends who are interested in your business idea and they would like to invest in your business. That may sound good on the surface to you, but even if this is the best arrangement for you, there are factors you must consider before you jump in. If you decide to accept investments from family and friends, you will be using a form of financing called equity financing.

Advantages of Equity Financing:

1. No repayment: The major advantage of taking the route of equity to raise funds for

the business is that the promoter is not bound to repay any amount. The investor buys a portion of the company, and gets the proportionate share of the profits or loss, as the case may be. Investors wishing to exit will have to sell their shares to someone else, and the company is not bound to repay the investment. This in sharp contrast to taking the debt route to finance investment, where the promoter will have to repay the amount and interest in fixed monthly installments, irrespective of whether the investment has borne fruit or not.
2. Immunity: Since investors share profits and loss, equity financing protects the

company during times of economic downturn and limits the promoters loss. A public listed company is a separate entity distinct from its promoter, and the promoter receives payment paid for the effort put in just as all other employees receive salaries, and shares the profit or loss, just like all other investors.
3. Good credit ratings: The involvement of many investors or a high equity base

improves the credit rating of the company, for this gives the impression of a venture backed by many investors, and having sufficient funds to compensate debtors if things go bad.

5 4. Better performance: The presence of ever-watching investors keeps the management

of the company on their toes to perform at their best.

5. Better corporate governance: The law requires public listed companies to maintain

impeccable records, hold regular general body and director meetings, audit their accounts, and follow other standard practices. This increases the quality of corporate governance and instills professionalism.
6. Easy exit: Raising money through equity by listing in the stock exchange makes it

easy for the promoter to offload his holdings to any other interested investor and quit the company without closing down the business. Similarly, any investor can recoup his or her investment at will, unlike fixed term debts.
7. Lower risk: Generally, its less risky to use equity financing rather than take out a

loan from a lender because you dont have to pay equity back like you would a loan. Equity cans a good option for businesses that arent in a place where they can take on additional debt.
8. Increase Cash Flow: With equity, youll generally end up with more cash on hand

that you can use for growing the business. Because investors are hoping to obtain a high return on their investment, theyll generally prefer leaving their money in the business to help promote growth. The ability to reinvest money within the company is vital for many small businesses.
9. Help to expand Business: Investors are often prepared to provide follow-up funding

as the business grows.

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Increase value of Business: In common with you, investors have a vested

interest in the business' success, i.e. its growth, profitability and increase in value.

Disadvantages of Equity Financing:

1. Loss of decision making powers: While raising equity is a good way to exit the

business, it becomes difficult for the interested promoter to retain control of the business. All shareholders of an enterprise have a say in electing the director board, including the CEO, and all major investments require the approval of a majority of the

shareholders. The shareholders have the right to question the management regarding any aspect of the company.
2. Loss of control: If the promoter does not match the investments made by other

investors, there is a chance of other investors acquiring more than 51 percent of the company shares and taking control of the company, forcing the promoter out.
3. Regulatory compliance: The strict adherence to rules and regulations, holding of

meetings, filing reports and the like increase the standards of corporate governance but also takes up valuable time, energy, and resources that could be best spend in improving the company core process.
4. Higher out go: While profit and loss sharing protects the company during bad

economic times and difficult cash flow periods, it also leads to a higher outgo to the investors during good economic times. The profit sharing in is proportion to the investment made by each investor, including the promoter, and the promoter would have to forego of a much higher amount when compared to repayment of bank loan with interest.
5. Lifelong obligation: Taking in investors is a permanent obligation, and the investors

have a right to stay put and take their cut of profits forever. This is in contrary to debt financing when all obligations end when the loan plus interest is repaid in full.
6. High returns sharing: In order to persuade investors to invest, you may have to

promise to pay higher returns than the rates youd pay to a bank or other debtor if you took out a loan. Taking on such high returns can cripple many small businesses.
7. Extensive time and expenses: Finding the right investors for your company isnt an

easy task. It often takes a significant amount of time, effort, and money just to find the right investor.

Debt financing:
Debt financing is borrowing money from external sources to run a business, or make new investments. The borrower receives the amount required, usually a large capital sum upfront, and agrees to repay the same with applicable interest in installments, usually equated monthly investments. Most debt financing are long term in nature. The borrower usually needs to pledge some collateral security such as existing assets as a safeguard for the creditor in the

eventuality that money invested does not bear fruit and the debtor is unable to repay the loan. An important source of this type of financing is the bank, but many private companies, and even friends and relatives offer such financing. Debt financing is a major type of funding and has both advantages and disadvantages.

Advantages of Debt Financing:

1. Control: Debt financing allows the borrower to retain ownership on the control of the

business, unlike equity financing which require the borrower to part with share of company ownership and surrender decision making autonomy. In debt financing, the third party creditor has no monetary interest in the business, except for the principal and interest income.
2. Retain Profit: Debt financing allows the entrepreneur to retain the profit earned by

the business without sharing it with the debtor. The lender does not have any share or stake in the profit and only gets the loan payments in the set time, and only for the agreed upon period. This is in contrast to equity financing which requires sharing the profits and losses for eternity.
3. Limited Obligation: In debt financing, the borrowers obligation ends with the

repayment of the principal and the interest to the lender. The obligations that come with taking up a partner in equity financing remains permanent and irrevocable, unless the partner willingly sells his or her stake and the entrepreneur can buy ut back at the price offered.
4. Tax Deduction: One of the most attractive aspects of debt financing is tax

advantages. The interest on borrowed money, paid to the lender is tax-deductible. This means exemption from paying tax for the part of business income used to pay interest, lowering the tax liability of the business.
5. Timely Payments: Timely repayment of debt enhances and improves the credit rating

of the business, making it easier to obtain other types of financing in the future.
6. Easy Administration: Debt financing is easy to manage and administer, and require

no extensive or complex reporting requirements. In contrast, issuing shares to source equity financing require compliance with complex regulations under the Federal and State Security laws and regulations.

8 7. Future Planning: In debt financing, the principal repayments and interest are

calculated before hand, and does not depend on market conditions. This allows for better planning and forecasting.
8. Less expensive: Long-term debt financing turns out to be less expensive for

businesses owing to spreading out of the capital repayment over many months, and the likelihood of the investments maturing and providing good returns as they reach its peak.
9. Predictability: With loans, you can be certain of the principal and interest payments

you owe and, therefore, you can budget precisely. Many small businesses appreciate this predictability as it can be easier to create a budget if you know exactly what money you will owe on a loan each month. In addition, you can imagine the unpredictability that comes with giving up equity in your business. For example, imagine how much Bill Gates and Paul Allen would have lost if they gave up 25% or so of Microsoft to a venture capital firm to raise initial financing relative to what they would have lost if they took out a $100K loan. If your business grows at the rate Microsoft did, you pay the same amount on the loan regardless.

Disadvantages of Debt Financing:

The advantages of debt financing notwithstanding, this financing model also have many shortcomings. Some of them include:
1. Repayment: A debt requires repayment irrespective of whether the debtor makes a

profit or loss with the loan. This is in contrast to equity financing where the repayment bases itself on the actual performance of the borrowed money
2. High Cost: The fixed interest costs can raise the companys break-even point, or the

point where no profit and no gain occurs.

3. Restricted Cash Flow: Debt repayments are a fixed obligation regardless of profits,

loss, or delayed payments. This raises the risk of insolvency for the business, especially during difficult financial periods.

9 4. Budget: Debt financing requires accounting and budgeting the principal and interest

in the cash flow statements.

5. Restrictions: Just as equity financing restricts the decision-making powers of an

entrepreneur, debt financing also impose restrictions such as not allowing for alternative financing options when the debt remains in place.
6. Collateral Security: Creditors require some type of collateral security to cover the

value of the loan.

7. Risk Outlook: Debt financing increases the company's risk outlook, for higher the

businesss debt-equity ratio, the more risky the company becomes for other lenders and investors.
8. Fixed payment terms: The money you borrow must be paid back within a fixed

period of time regardless of how successful your business is. These required monthly (or quarterly) payments can be the straw that breaks the camels back for struggling small businesses.
9. Cash flow problems: If you rely too heavily on financing your business with debt,

and you end up with cash flow problems, you will have serious problems trying to stay up-to-date on your loan payments. Comparing the advantages and disadvantages of debt financing, debt financing remains suitable if the cash is put to high growth ventures with stable cash flows.

Conclusion:
In conclusion the debt vs. equity financing of business is a very difficult decision and a crucial one which will affect the viability of the company and also affect the growth in the future. As discussed above the two sources of finance has their advantages and disadvantages and one must balance these advantages and disadvantages depending on the nature of operations, risk factors and the personal and impersonal nature of these financing tools. That is in ideal situation one must have equity financing which is not too personal or loan or debt financing which is not too impersonal which is strange but it is an ideal one for any business whether new or established businesses.

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