Finance loans play a very major role in business. Finance is equally needed to start a business as well as to run and maintain the business smoothly. Financing can be mainly classified into three – Self Financing, Debt Financing and Equity Financing. Normally big businesses will not opt for self financing; they will always go for either Debt or equity financing.
Debt financing means fund raised by the business people, by borrowing money from any financial institutions like Bank. In this case the business owners need to repay the loan amount in small installments added with an interest rate. But in equity financing, to raise the fund, the business people will sell a part of their business to a third party.
Let us see how debt financing differs from equity financing.
• One of the main differences between Equity and debt financing is that, in equity financing the financier will have a freedom to interfere in the functioning of the business. But in Debt financing, business person will have the only ownership and rights on the business, the bank cannot interfere in any of the business activities. Role of the bank is only to provide fund for the business.
• Funds can be raised very easily through debt financing when compared to the equity financing. Many legal laws and regulations need to be obeyed in case of equity financing.
• In Debt financing, bank or any other financial institution that lends money, will not have any rights on the profit made out of the business. But in equity financing this is not the case; profit will be shared by both lender and business owners as per their agreement.
• More cash flow will be available in equity financing than the debt financing. This is very advantageous in equity financing because, cash flow will help to run the business more smoothly.
• Another disadvantage of Debt financing is, the loan repayment should be done within a predetermined period of time, even if your business is in loss. This will create more pressure on the business owners. But in equity financing this pressure is less.