Explain the relative merits of equity financing versus debt financing.

Expert Solution

Equity financing:

With equity money from investors, the owner is relieved of the pressure to meet the deadlines of fixed loan payments. However, he does have to give up some control of his business and often has to consult with the investors when making major decisions.

Merits of Equity Financing are as follows:

You have less risk with equity financing because you don't have any fixed monthly loan payments to make
Equity investors do not expect to receive an immediate return on their investment. They have a long-term view and also face the possibility of losing their money if the business fails
With equity financing, you might form informal partnerships with more knowledgeable or experienced individuals. Some might be well-connected, allowing your business to potentially benefit from their knowledge and their business network
You will have to distribute profits and not pay off your loan payments

Debt Financing:

Borrowing money to finance the operations and growth of a business can be the right decision under the proper circumstances. The owner doesn't have to give up control of his business, but too much debt can inhibit the growth of the company.

Merits of Debt Financing are as follows:

When you agree to debt financing from a lending institution, the lender has no say in how you manage your company. You make all the decisions. The business relationship ends once you have repaid the loan in full
The amount you pay in interest is tax deductible, effectively reducing your net obligation
You can choose the duration of your loan it can either be long term or short term
Principal and interest payments are stated in advance, so it is easier to work these into the company's cash flow

jeff jeffy answered 7 months ago

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