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Debt vs. Equity Finance

Debt vs. Equity Finance

In order to expand your business, it is important to understand the two main financing methods. Equity requires investors while debt, which is familiar to most people, is a temporary loan that needs to be paid back with interest.

Equity financing involves bringing in investors who provide capital in exchange for a share of the business. This is the strategy that companies use on the popular TV shows, Dragon’s Den and Shark Tank. Unlike debt financing, you are not required to pay back the loan, even if the company does not make profits. Investors don’t require an immediate return on investment since investors are looking at the big picture of the company.

Getting written a check may seem like the perfect solution, but this comes with major strings attached since you no longer retain the exclusive rights to the company. Therefore, you need to split the profits with the venture capitalists.

Debt financing involves borrowing money from a financial institution or bank and usually requires good credit. Taking on debt scares many business owners because they fear that they will be unable to repay the debt along with the added on interest. With debt financing, full ownership of the company is still in your hands. Taking on debt can also help with future borrowing since it can build up credit if the payments are made in a timely manner.

Unlike equity financing, debt must be repaid at some point. Cash flow is required otherwise the payments pile up and therefore make it harder to repay. If the debt-equity ratio is too high it will push away any future investors since the company will be considered a risk to invest in.

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