Question

Elaborate on the concepts of debt vs. equity financing. What are the advantages and disadvantages to a taxpaying entity in issuing debt as opposed to equity?

Answer 1

Debt financing involves borrowing money from a bank or financial institution, to fund once business and repay the money over a period of time. Getting a business loan requires good credit rating along with strong financials and collaterals. Irrespective of the many preconditions for the debt financing, it does have a lot of advantages over equity financing.

The most important advantage of debt over equity financing is that one does not lose control over their own company. Equity financing involves sharing decision making powers as well. This can be avoided by opting debt financing.

Equity financing requires the investors to be convinced of the profitable nature or the potential the business has so that they may invest in the company. On the contrary, debt financing can fund any business as long as the credit is good enough to get a loan from banks or institutions.

Taking a debt may also help in building up credit over a period of time. Prompt repayment of loans would help in increasing credit score and thereby increasing chances of getting a bigger loan for long term investment plans.

As loans are tax deductible, if properly planned, debt can also be used for reducing taxes there by improving the bottom line of the company. This advantage is not available in case of equity financing.