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When to Choose Debt vs Equity Financing for a Business Venture
Whether just starting out or seeking growth, businesses may from time to time need to raise capital. To do so, companies will turn to one of two financing sources, both with their advantages and disadvantages: debt and equity financing. A qualified business attorney can represent businesses seeking debt or equity financing.
What Is the Difference Between Debt and Equity Financing?
In debt financing, a business takes on loans to finance its operations and must repay the debt. Equity financing refers to raising money by exchanging ownership shares. There is no repayment obligation with equity financing.
What Factors Influence Whether to Choose Debt or Equity Financing?
When thinking about whether debt or equity financing is the right choice for your company, you will need to consider factors including your company’s:
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Financial needs
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Risk Tolerance
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Long-term objectives
When Is Debt Financing Preferable?
Debt financing is ideal for businesses that have a plan in place to pay back the loan. A business in need of capital for operations growth but that also has a good revenue model would be a good candidate for this type of financing. It can be helpful to look at debt financing as the "stick" method of obtaining capitalization; the borrower who does not pay up will face consequences.
What Are the Advantages and Disadvantages of Debt Financing?
Advantages
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Founders and stakeholders retain ownership and control. Once the loan is paid off, there is no more liability.
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Obligations to the lenders stop after the debt is repaid.
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The founder only pays the loan principal even if the business succeeds; no ownership rights are granted.
Disadvantages
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Companies must pay back the loan, and if the business does not have the money, it may be forced to file bankruptcy.
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A personal guarantee is sometimes required.
When Is Equity Financing Preferable?
Equity financing is a popular financing method with early-stage founders because investors are attracted to the potential to receive a high return. Think of equity financing as the carrot method: the borrower does not have to rely on debt or pay anything to the investor. Instead, the investors receive a return on a future sale of the company if all goes well.
What Are the Advantages and Disadvantages of Equity Financing?
Advantages
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This is a higher-reward investment type because investors may see their shares grow in value if the company succeeds.
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There is no repayment obligation.
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Investors bring not only cash but knowledge and guidance to a business.
Disadvantages
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This is a higher-risk investment method because there is no guarantee of return, which can make it more challenging to find the right investors.
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Ownership control is diluted with each subsequent investment round.
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Equity financing tends to have more costs in the long run.
Contact a Broward County, FL Business Financing Attorney
When your business seeks to raise capital, a Fort Lauderdale, FL business financing attorney with experience with investments and venture capital can address your legal concerns. At The Elliot Legal Group, P.A., attorney Gavin Elliot understands how the legal side of business financing affects business operations and can represent your enterprise during the capitalization process. Call 754-332-2101 for a consultation today.
