Choosing the correct mode for raising capital for business is a preliminary but gruesome task. Numerous factors are considered before opting for any one financing service for the company. Moreover, if you need outside help for funding, you better ask the right set of questions to make a suitable choice. Basically, there are two choices when it comes to investing in a new business: Debt Financing & Equity Financing.
Thankfully, these days Finance Software is eligible enough to guide intelligent moves for the business that can also benefit investors and mortgagees. Based on the data it collects, the software helps founders to conduct a healthy relationship with moneylenders and shareholders.
This article will show a clear difference between debt financing and Equity Financing to help you pick which is better for your organization.
What are Debt Financing & Equity Financing?
Debt finance encourages owners to borrow money from an institution without giving away company ownership. Debt financing binds the company owner to pay the principal amount and interest rate on a specific time period agreeable to both parties. The owner can face severe consequences if he/she doesn’t meet the terms and conditions of the bond.
Equity financing helps to generate capital with the help of shareholders. In this process, the founders sell the company’s stocks to buyers and make them a part of their growth. In this case, the founders do not have to return the money as the shareholders put cash in the company as an investment. However, the investors, shareholders, etc., are eligible for a dividend, and the founders have to share the company’s profit with them based on the ownership of the shares.
A combination of equity and debt financing is also a renowned concept in the market where the ideal debt/equity ratio is 1:2. In this case, the equity ratio is always double of debt for the financial safety of a firm.
Key Differences Between Debt Financing & Equity Financing
These are some of the identifiers that can easily differentiate debt financing and equity financing from each other. Before capitalizing, business owners discuss these significant attributes with accountants and experts. In essence, Accounting Software helps accountants and bookkeepers take note of the financial transactions of an organization without making them complicated.
Small businesses and term loans, business credit cards, peer-to-peer lending, bank & personal loans, lines of credit, equipment loans, mortgages, etc., are leading examples of debt financing.
IPO, angel investors, corporate investors, venture capitalists, and crowdfunding are famous examples of equity financing.
2. Nature of Capital
Debt financing is a liability/loan of a firm where the lenders can claim their money with interest. Hence, a loan becomes an obligation for owners to pay back on a mutually agreed time, even if the company succeeds or not. Finance software helps businesses to keep tabs on timely payments.
Equity financing is an asset of a firm where the money comes from owners, not outsiders, and is a long-term financial facility. Hence, investors become company owners with almost the same rights as the founders and are rightful partners of profits. Accounting software guides BOD in making productive decisions that can increase the company’s market value and the faith of shareholders.
3. Risk Factor
Debt financing doesn’t involve a huge risk. Yet, a company is tied to paying the loan amount with interest, regardless of the outcome. That’s when finance software comes in handy to create a blueprint for a company to optimize capital and avert losses.
Equity financing comes with huge risks as an investment. Hence, proper accounting software is needed for an organization that can promptly direct the management team to make careful and effective decisions for the business to get the best ROI.
A debt financier is a lender to the company who has no control over the company’s management.
Equity financing welcomes ownership in a company in the form of shareholders, investors, stakeholders, etc. They play a major role in making decisions. You can buy out shareholders or let investors run your business during a disagreement.
5. Return of Payment
Debt financing demands regular and fixed payments with interest to the lenders.
Equity financing doesn’t bind founders to return investment money to the owners, but they are obliged to share profit margins.
6. Tax Benefit
The advantage of debt financing is the interest you pay on a loan after deducting taxes.
There are no such legal advantages of equity financing. However, if a business doesn’t work, the founders have no obligation to pay back shareholders. Moreover, higher equity creates credibility and cash flow for the company.
Numerous companies prefer debt financing to avoid sharing ownership, especially small startups as they might not have a reasonable amount of assets. On the other hand, companies with prestigious market value and a higher debt ratio prefer to use the parent company’s name to influence people into investing money in their new venture. This is because 85% of people want their investment to impact society positively. In both scenarios, accounting software and finance software will always be around to offer a better path to the growth and cultivation of a company.