Debt vs equity financing - definition and pros and cons

When aiming to grow your business, the question of which financing strategy to use is key. Whether it is crowdfunding, institutional investors, or loans - there is no shortage of options. However, two of the most common sources of financing are debt and equity. We have compiled a short guide to the pros and cons of each of those methods.

Debt and equity financing defined

Debt financing describes borrowing money from a lender, typically a bank. This means that debt financing describes a number of ways to raise capital (eg loans, credit cards, overdrafts, and lines of credit). This means there is a repayment obligation over time which might come with additional interest payments or fees. As there are not many barriers to this type of financing, it is recommendable for younger start-ups. Equity financing, on the other hand, describes selling shares of your business. There are also many different forms of equity funding. Some well-known ones include angel investment and private equity firms.

Debt Finance - yes or no?

When using debt finance to raise funds, there is no loss of control over your company. There is also a time limit as once the debt financing occurs and the debt is paid off, there is no more liability. However, there will be principal and interest obligations in repaying your debt. If you and your business are then unable to pay these, the lender may end up taking the assets/guarantees you used as security. With this type of financing, debt can easily spiral out of control if you don’t have a full understanding of your fees, especially if you’re on a variable interest rate loan. The riskier your industry, the less likely it is for you to be successful with debt finance.

Equity financing - yes or no?

Equity financing can improve expertise in your company - equity investors can provide fantastic sources of expertise and advice. With this input, your business can become an even more successful company. The second perk of equity financing is that there is no need to repay debt while your company is still growing. Disadvantages of this method include the loss of control. You are giving up decision-making power. Also, giving up a certain proportion of profits for the rest of the business’s life is risky in itself. Managing shareholders, keeping them up-to-date, and even initially finding investors can be very time-consuming.

Which one shall I choose?

To make the right call, ensure you know what you value in your business. Do you care more about control over your company or would the added expertise benefit your company? Also, do not forget to consider the monetary side.