Business Funding – Debt financing vs equity financing
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DEBT. VS. EQUITY
Debt financing means borrowing money that is to be repaid over a period of time, usually with interest. Debt financing can be either short-term (full repayment due in less than one year) or long-term (repayment due over more than one year). In simple words, this means borrowing funds from lenders, banks, organizations etc.
Equity financing describes an exchange of money for a share of business ownership. This form of financing allows you to obtain funds without incurring debt; in other words, without having to repay a specific amount of money at any particular time. In simple words, this means, selling shares or stock of your company and inviting other people to contribute capital giving them a share of profits in return.
Debt and equity financing provide different opportunities for raising funds, and a commercially acceptable ratio between debt and equity financing should be maintained.
Excessive debt financing may impair your credit rating and your ability to raise more money in the future. If you have too much debt, your business may be considered overextended and risky and an unsafe investment. In addition, you may be unable to weather unanticipated business downturns, credit shortages, or an interest rate increase if your loan’s interest rate floats. Conversely, too much equity financing can indicate that you are not making the most productive use of your capital; the capital is not being used advantageously as leverage for obtaining cash. Too little equity may suggest the owners are not committed to their own business.