Advantages And Disadvantages Of Debt Finance Over Equity Finance

Explain the advantages and disadvantages, to a company, of debt finance over equity finance. 800 words

“Absolutely nothing is more important to a business than raising capital," Steve Jefferson wrote in Pacific Business News (Jefferson, 2001). Basically, there are two types of finance 's source for a start-up company or business expansion such as Zimmer plc. In a formal way to explain, debt finance considers as a long-term loan that you can borrow the money or taking on a loan from the commercial bank and repaid with interest that has agreed. While, equity finance is using conditions such as selling interests or exchange for a share of ownership in the business from family, friends or business owner to raise money in private sector. They do

The company just has to pay back the money plus interest that has agreed based on the contract. Normally, the interest that has to pay back is in a fixed percentage; therefore it makes the company easier to create a budget plan and use the money efficiently so they can maximize the profits and also return the loans timely. In addition, they can prevent the unpredictable issue such as carrying too much of debts or cash flow problems. Moreover, debt finance has simple obligation in loan repayment because they just have to pay back the loans based on the agreement. But equity finance is more complicated as they have to implement with laws and regulations. Once the company paid back the loan, the relationship of the company and the lender will end, no direct claim in the company future’s earning. It is totally different with the equity finance because they have to share certain of profits with the investor and sometimes it may exceed the interest that you have to pay to the lender. Even the company is success; the owner can’t enjoy the privileges because you may have to promise higher return rates to the investor to get the

Sometimes, new business may unable to make it when they don’t have enough cash flow in the company. Whereas, equity finance only need to pay back the profits if their business is going well. Another disadvantage is the loans that borrow from banks could be limited so they must find other ways to raise the capital. According to debt finance, the bank will investigate the company financial status before they approve the loans. If the company does not fulfill their requirement such as carrying too much of debts or company performance does not doing well, they will reject it because they will consider the risk level. The high-risk company usually will be hard to get loans. Borrowing loans from bank usually need to mortgage the assets of the company in order to guarantee the repayment of loans after a period of time. If the company faces downturn, the bank might have to collect the assets that the company uses to pledge for the loans because the lender still want back the money even the business