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Debt and Equity Financing.16bbl022

The document discusses the pros and cons of debt financing versus equity financing for a business. For debt financing, the pros are retaining control of the business, tax advantages from interest payments being deductible, and easier financial planning. The cons are being obligated to repay loans even if the business fails, potentially high interest rates, negative impacts to credit rating, and needing sufficient cash flow and collateral. For equity financing, the pros are less repayment burden, no credit issues, and potential learning from partners. The cons are needing to share profits with investors, losing some control, and potential conflicts between partners.

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juhi
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109 views2 pages

Debt and Equity Financing.16bbl022

The document discusses the pros and cons of debt financing versus equity financing for a business. For debt financing, the pros are retaining control of the business, tax advantages from interest payments being deductible, and easier financial planning. The cons are being obligated to repay loans even if the business fails, potentially high interest rates, negative impacts to credit rating, and needing sufficient cash flow and collateral. For equity financing, the pros are less repayment burden, no credit issues, and potential learning from partners. The cons are needing to share profits with investors, losing some control, and potential conflicts between partners.

Uploaded by

juhi
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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DEBT AND EQUITY FINANCING- PROS AND CONS

- Juhi Hirani
(16bbl022)

DEBT FINANCING

Advantages-

1) Retain control: When a lender agrees to debt financing from a lending institution, the
lender has no say in how you manage your company. Lender makes all the decisions. The
business relationship ends once the loan is paid in full.
2) Tax advantage: The amount one pays in interest is tax deductible, effectively reducing
the net obligation.
3) Easier planning:  It is well known in advance that how much principal and interest is
needed to be paid. This makes it easier to budget and make financial plans.

Disadvantages-

1) Repayment: The sole obligation is to make payments to the lender even in course of


failure of the business. And the lenders will have a claim for repayment before any equity
investors in case of bankruptcy.
2) High rates: Even after calculating the discounted interest rate from the tax
deductions, there still might be a high-interest rate because these will vary with
macroeconomic conditions, history with the banks, business credit rating and personal
credit history.
3) Impacts on your credit rating: It might seem attractive to keep bringing on debt when
the firm needs money, a practice knowing as “levering up,” but each loan will be noted
on the credit report and will affect the credit rating. The more one borrows, the higher the
risk becomes to the lender so there is a higher interest rate on each subsequent loan. 
4) Cash and collateral: Even if there is a plan to use the loan to invest in an important
asset, one have to be sure that the business will generate sufficient cash flow by the
time repayment of the loan is scheduled to begin. It is most likely that a collateral is put
up to protect the lender in the event of default.

EQUITY FINANCING

Advantages-

1) Less burden: With equity financing, there is no loan to repay. The business doesn’t have
to make a monthly loan payment which can be particularly important if the business
doesn’t initially generate a profit. This in turn, gives one the freedom to channel more
money into your growing business.
2) No Credit issues: If one lacks creditworthiness through a poor credit history or lack of a
financial track record, equity can be preferable or more suitable than debt financing.
3) Learn and gain from partners: With equity financing, informal partnerships can be
formed with more knowledgeable or experienced individuals. Some might be well-
connected, allowing the business to potentially benefit from their knowledge and their
business network.

Disadvantages-
1) Cost: Equity investors expect to receive a return on their money. The business owner
must be willing to share some of the company's profit with his equity partners. The
amount of money paid to the partners could be higher than the interest rates on debt
financing.
2) Loss of Control: The owner has to give up some control of his company when he takes
on additional investors. Equity partners want to have a voice in making the decisions of
the business, especially the big decisions.
3) Potential for Conflict: All the partners will not always agree when making decisions.
These conflicts can erupt from different visions for the company and disagreements on
management styles. An owner must be willing to deal with these differences of opinions.

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