Equity Financing – The most commonly used financing method by the business organization is equity financing. Equity in accounting stands for ownership. Therefore, equity financing is a type of financing method in which business organizations sell their equity. In equity financing, all the risk is transferred to the persons who contributed the amount. In case the business organization fails, the equity shareholders get nothing.
In simple terms, most of the right and control is transferred with equity. An equity shareholder gives money against control and ownership of the business organization. In equity financing, the shareholders receive dividends as their regular income.
Debt Financing – The other most important and common type of financing is debt financing. Debt financing is the type of loan. Most of people and business organizations acquire the method of debt financing. This can be in the form of loans or mortgages. Repayment is important in the case of debt financing. The financiers provide such loans on a particular rate of interest. This interest is paid to financiers in exchange for their money. Collateral securities are sometimes required by some lenders. If the asset is be used as collateral, then the debt is more easily obtained. There is no transfer of ownership and rights to the lender and the debt has to be paid back even if the business organization is facing difficult times.
Advantages and Disadvantages of Equity Financing
The equity is provided to the business organization from the investors, and the ownership rights are transferred thereof. Some of the advantages and disadvantages of equity financing are stated as follows:
Less risk – Equity financing has lesser risk involved with equity financing. This is because there is no need to make regular payments such as loan payments are made. Equity financing proves very useful in startups.
Credit problems – The other advantage of equity financing is that it reduces credit problems. Equity financing helps in the financial growth of the business organization. Some business organizations take equity financing along with debt financing.
Cash flow – The other advantage of equity financing is that is provided a smooth cash flow. Unlike debt financing, no repayments are made, which take funds out of the company’s cash flow.
Cost – The first drawback of equity financing is the cost associated with equity. The owner of the business organization has to share the profits of the business organization with the equity shareholders. This share of profit could even be higher than the rates of interest on debt financing.
Loss of Control – The second drawback of equity financing is that the business owner has to give up ownership rights and control over the business organization. Equity shareholders can take part in all the decisions of the business organization.
Advantages and Disadvantages of Debt Financing
The debt is provided to the business organization from the lender and receives the interest at fixed rates. Some of the advantages and disadvantages of debt financing are stated as follows:
Control – The main advantage of debt financing is that no control is transferred. This is because the loan is temporarily granted. The relationship between the lender and the borrowers ends at the repayment of a loan or debt.
Taxes – The other advantage of debt financing is that the interest payment of debt is a deductible expense under income tax. The dividend payment, on the other hand, is not deductible.
Fixed payments – The first disadvantage of debt financing is the fixed payments related in debt financing. The repayment of principal and interest payments must be made on fixed dates. Business organizations may find difficulties in making loan payments.
Collateral – Sometimes, the lenders demand certain assets to be held as collateral security. This is sometimes not possible with all the individuals and business organizations requiring debt financing.
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