Comparing Debt and Equity Financing


When a business reaches the point where outside funding is needed, there are two basic forms of financing to consider: equity and debt. With equity financing, a share of the company is sold in return for funding. The alternative is to take on debt by borrowing money.

It is important to understand the pluses and minuses of debt vs. equity financing, and it is equally important to understand that your business may not qualify for certain financing options. For instance, you can rule out equity financing if no one wants to buy a share in the ownership of your business.

 

Debt Financing
Pluses Minuses
  • Does not dilute owners’ share of the business
  • Funding from alternative lenders can feature flexible repayment terms
  • Short- and long-term options may be available
  • Alternative options can provide immediate access to capital
  • Adds debt, plus interest or other charges that must be repaid
  • Most conventional bank loans require collateral and the business owners’ personal guarantee
  • Low approval rate for traditional bank loans
  • Personal credit history is a major factor traditional bank loan approval
Equity Financing
Pluses Minuses
  • Money does not have to be repaid
  • No interest charges
  • Investments are tailored specifically for each business
  • Investors may provide expertise that aids in the running of the business
  • Investors receive a share of the business; owners’ share is diluted
  • Depending on the structure of the investment, investors may be involved in controlling decisions
  • Limited availability
  • May take months to finalize terms

 


 

How large is the business finance marketplace?

In 2013, The Wall Street Journal reported that U.S. banks had more than $1.45 trillion in business loans outstanding. Most of those loans have been made to large businesses, with just 5 percent of all the loans made by large banks going to small businesses according to AmericaBanker.com.

Since the end of the Great Recession, growth in the business lending market has been driven by loans to large businesses, while lending to small businesses has declined significantly. In fact, according to FDIC data, the share of nonfarm nonresidential business loans going to small businesses has declined from 51 percent in 1998 to just 26 percent today.

While famous venture capitalists make news with big investments in sexy startups, most business capital comes from other sources. In fact, personal loans and investments from friends and family account for most startup funding.

According to data reported by Entrepreneur.com, of the $533 billion in annual startup funding in the U.S., $42 billion provided by venture capitalists and angel investors goes to less than one percent of new companies. By comparison, 57 percent of startups use personal loans and credit, and 38 percent report funding from family and friends.

 

Learn about: Common Sources of Business Financing
Learn About: Factors & Qualify for Business Financing
Learn About: Online Resources for Business Financing
Learn About: Frequently Asked Questions

 

 

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