Debt and equity are two very different financial terms that can be used to describe a business’s financing resources. When your business is looking to expand, you have to find some money to allow that expansion. Debt requires your business to borrow money that will have to be repaid in the future. Equity means that the business would have to sell interests in the company to raise money. There are advantages to both, as you will see.
Advantages of Debt Compared to Equity
In certain situations, taking out a loan may be a better option for your business. A debt is advantageous because it:
- Does not give a claim of equity in the business to the lender, so your interest in the ownership of the company is not diluted.
- Does not give the lender claim on future profits of the business because the lender is only entitled to the principal plus interest.
- Gives you a larger portion of the rewards should your business be successful, because you did not have to sell any stock in the company.
- Is typically able to be planned for because the amount you have to pay is known ahead of time.
- Is partially tax deductible in that the interest can be taken from the tax return, which lowers the overall cost of the loan to your company.
- Is less complicated than equity because your company does not have to comply with the federal and state securities laws and regulations.
- Can be done without holding shareholder meetings or sending out mailings to investors.
If you do not want to sell any of the equity in your company, taking on a debt is obviously the better choice.
Advantages of Equity Compared to Debt
Similarly, there are certain situations where equity is better than taking on more debt. Equity can be advantageous because it:
- Is a way to get money that does not have to be repaid.
- Takes into account the cyclical nature of business in that you will not have to worry about making the same high payments on a debt even when your company had a bad month.
- Does not raise your company’s break-even point like high interest would.
- Makes future growth easier because you do not have more debt than you do equity.
- Allows your management to continue pursuing other financing options and non-core business opportunities.
- Is sometimes considered more affordable because companies have only a certain amount of debt they can carry before they are considered too risky to loan money to.
- Does not require that you pledge assets of the company to the lender because you are just selling a part of your stock.
If your company is at a point where more debt is just a bad idea, selling some equity may be the choice for you.
Consider Your Options
Growing your business is an important part of continuing to ensure success. That means you have to find ways to finance growth. That can be a difficult task when your money is tied up in other avenues. If you have to choose between taking on debt or selling equity, you have to make some serious considerations. Find the path that is right for you. Do not just do what everyone else is doing. Your path and your choice can be different than that of other businesses.
As you consider your options, it is a good idea to work with a financial advisor. An expert will be able to educate you on the law and regulations connected with both financing options. He or she will be able to help you figure out which option is really right for your company. Consider all of your options. Think about your company’s current financial standings and the goals you have for the future. All of these considerations will help you make an educated decision.
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