Equity Capital Vs. Debt Financing: What’s the Difference?

It’s common for companies growing faster than their current income to seek outside capital to keep up their momentum. An under-capitalized business will find it difficult to make the leap required to scale and expand.



A clear first step to lining up outside capital is to determine whether equity investment or debt financing (or a combination of the two) might be the best route for your business.





What Is Equity Financing?



When you own a business concept or company, there’s a subjective value attached to it called equity . The equity of any type of asset—whether intellectual or physical—is the value someone is willing to pay for it, minus its liabilities. That could mean the value of an entity today (measured in time and money invested) versus its value in the future (measured by comparable growth).



Once the owner and investor determine the “valuation” of the asset, the owner can then sell parts of the equity to raise capital. 








Types Of Equity Financing



There are a variety of methods to raise equity capital, including seed capital, angel capital, and managed venture capital. Here’s a closer look at each of these popular equity financing solutions. 



Seed Capital



Seed capital typically comes from private investors (often personal sources like friends and family members) during the startup phase of a company’s development. It only qualifies as equity financing if the investor receives a piece of the company in return for its investment.



Angel Capital



Angel capital comes from angel investors —typically high-wealth individuals who invest in businesses (startups included). In exchange for angel capital, an investor will require a piece of the companies in which they invest.



Managed Venture Capital



Venture capital funds come from managed, pooled investments. This type of funding is usually only available to startups with the potential for rapid growth and high returns. Again, you’ll have to give up a share of your business in exchange for the investment dollars you receive. 







Pros Of Equity Financing Cons Of Equity Financing No debt obligation to repay Lose a measure of control in your business Potential to gain insight from knowledgeable business partners Must share profits Credit problems aren’t an obstacle to funding Doesn’t help build business credit








What Is Debt Financing?



Debt financing is a source of business funding where a lender provides to the business an agreed-upon amount of money that is to be repaid over a period of time, in addition to any associated fees or interest.








Types Of Debt Financing



Like equity financing, there are various ways to secure debt financing as well. Below are four popular debt financing options to consider for your business. 



Business Loans



A business loan can provide you with a lump sum you can use to invest in your business. You must repay the money your business borrows, plus interest and fees, according to the lender’s terms. 



A/R Financing



Accounts receivable financing lets you use your business’ unpaid invoices as collateral to borrow a lump sum of money—often up to 80% of the invoice value.  



Equipment Financing  



Equipment financing can provide your company with asset-based borrowing solutions to purchase or lease essential business equipment.



Line of Credit



A business line of credit is a flexible form of financing that lets you borrow up to a certain amount (a.k.a. your credit limit). However, you pay interest only on the funds you actually borrow. 







Pros Of Debt Financing Cons Of Debt Financing You maintain control. It might be difficult to qualify with bad credit—especially with traditional business loans. Interest on business loans and credit cards is tax deductible. You risk borrowing more than your business can afford to repay. Attractive interest rates are often available with SBA loans and other financing options.  You risk losing collateral, if your business doesn’t repay its debts as promised.  It enables you to build up your business credit (if the lender reports to a business credit reporting agency).  Your personal credit might be at risk if you sign a personal guarantee and the business defaults on its debt.  








When To Choose Equity Vs. Debt Financing



Every business has to choose for itself whether equity financing or debt financing makes the most sense, and many companies opt for a mixture of both types of funding. There are risks with either option you choose. 



If your business closes and it still owes outstanding debts, you may still have to repay those loans plus interest. The same isn’t true with equity financing. On the other hand, if you sell your business for a sizable profit, paying off shareholders could be much more expensive than the cost of paying off a business loan. 



It’s up to you to weigh the pros and cons of each type of financing and figure out which solutions make the most sense for your business. 



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Information provided on this blog is for educational purposes only , and is not intended to be business, legal, tax, or accounting advice. The views and opinions expressed in this blog are those of the authors and do not necessarily reflect the official policy or position of Lendio. While Lendio strivers to keep its content up to-date, it is only accurate as of the date posted. Offers or trends may expire, or may no longer be relevant.



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