When is Equity Financing a Better Option than Debt Financing?

Learn when companies should opt for equity financing over debt financing. Understand why debt and equity financing are different and how they can affect your business.

When is Equity Financing a Better Option than Debt Financing?

Equity financing may be a more attractive option than debt financing for companies that are just starting out or are not yet profitable. This is because there is no loan to repay or guarantees at stake, and no need to make periodic payments that could affect cash flow and growth. Some business owners prefer to use a combination of debt and equity financing over time, with a preference for equity financing in the early stages of their business. However, others opt for one or the other in the long term, focusing on either debt payments or capital investments. Debt financing is preferable when a company does not want to sell any shares.

If a corporation believes in its numbers, it doesn't want to lose the profits it would have to provide to shareholders if the shares were given to someone else in debt or equity financing. Angel investors are people who provide funding to a startup while it is still in its early stages. On the other hand, if your business is experiencing a recession or having difficulty generating enough cash flow to cover loan payments, this can lead to financial difficulties and potential consequences, such as default or bankruptcy. Your financial health, the amount of principal and the type of collateral you use are factors that influence the cost of the loan. Equity financing does not require monthly payments, so the corporation has more capital to invest in the company's growth. If you run a startup in a high-growth sector (which is attractive to venture capitalists) and you want to grow quickly, equity financing may be a better option for you than debt financing. When you choose equity financing, you're giving part of your company's future value to investors, so it's critical to understand the implications of paying shares.

Whether through friends and family, angel investors or venture capital firms, each type of equity financing offers different advantages and ownership rates. Maintaining control of your company may be the best reason for choosing debt financing. One of the most important advantages of equity financing is that it requires no return and provides additional working capital that can be used to expand a company. Raising capital at critical moments is advantageous because it demonstrates the company's potential and allows investors to imagine what the return will be like in the future. Entrepreneurs often assume that equity financing is readily available, but that's not always the case. The WACC is calculated by multiplying the percentage costs of debt and equity in a proposed financing plan by a weighting equal to the proportion of total capital represented by each type of capital. Many early-stage organizations would seek equity funding, while those that are well-established and have a good credit score may choose typical debt financing options, such as small business loans.

On the other hand, when opting for debt or equity financing, you sell part of your company. Whether you ultimately choose debt financing, equity financing, or both, business growth could happen quickly.