Question

One of the major obstacles entrepreneurs face in starting their ventures is financing. Not only is locating a source for financing a challenge but also the type of financing that should be attained. For this discussion describe the differences in equity and debt financing identifying the advantages and disadvantages of each. Then state which type of financing you would prefer if you were starting a new business and provide reasons.

Your grade is calculated based on your original post AND response to classmates. Please respond to at least two other students. Your team’s discussion and responses must be substantive. As a guideline, your discussion should be 3 -4 paragraphs comprised of 5 -7 sentences per paragraph. Your responses should be 2 -3 paragraphs with 5-7 sentences per paragraph.

Answer 1

First of all lets understand the terms equity and debt financing

In equity financing the company gives its investors a certain stake in the company and does not have any interest or principal repayment obligations.

In debt financing company raises money from banks, financial institutions to expand or start its business or for any other purpose, but it has to serve timely interest and principal repayment obligations.

Now lets discuss the advantages and disadvantages of each

Equity Financing Advantages:

1. As compared to debt financing equity financing are considered less risky due to non obligation of interest or principal repayments on loan.

2. If your credit rating is not good or your organisation are facing credit problems, equity financing can be considered a good source than debt financing since in this case you would have to pay more interest on loans because of credit problems in case of debt financing.

3. The third advantage in case of equity financing is that the equity investors does not expect an immediate returns on their investment rather they invest with a perspective of long term investment.

Equity Financing disadvantages:

1. Since equity investors demands a return in case of company earning good profits, in that case the return paid to equity investors might exceed the interest paid to the debtholders.

2. When using equity financing as a source of finance, the company needs to give some control to the investors. In that case the company might not be able to take the decisions on its own.

3. In a particular situation, all of the members of the company might not agree to a particular decision, in that case there may be a situation of conflict of interest, companies using equity financing must be ready to face these situations.

Debt Financing Advantages:

1. Whenever one takes a loan it is not in permanent in nature, means it must have a fixed repayment schedule. So once the loan is repaid the lender does not have to care what business the owner is engaged in.

2. Payment of interest is a tax deductible expense, means it is a kind of savings on the total debt of the company.

3. Since in most of the loans the interest and principal repayments are known in advance, so one can prepare accordingly and manage its business to timely serve the debt obligations.

Debt Financing disadvantages:

1. Today in most of the banks, before giving a loan at reasonable rate of interest banks demand good credit rating from an external credit rating agency.

2. Since the principal and interest payments are to be made on time as specified in the repayment schedule, in case of company not able to generate enough cash flows, it might cause delays in servicing the interest and debt component.

3. Banks often demand collateral as a fixed percentage against the loan before providing the loan to the borrower as well as the personal guarantee of the borrower, In case of insufficient collateral, banks might not entertain the case of giving loan to the borrower.

If we are starting a new business equity financing would be a better way as a source of financing because start ups usually does not have much assets in their balance sheets and without collateral, most banks deny the debt financing because of the riskiness to the debt provided. Whereas equity investors provides financing in the hope of earning good returns in the future by investing in the startups.