Equity funding denotes the provision of capital for a venture through the trading of business shares. This may be a partial or complete sale of ownership of the company's equity in exchange for cash or other assets. The finance is paid into the company by an outsider who is an investor in the business. The investor obtains some ownership of the company through the investment, but does not receive repayment nor interest from the company ( Huang, Ritter, & Zhang, 2016) . When using equity as the source of business finance, the company issues equity shares to the investor whose value should be proportional to the money invested. Investors inject their money into companies with the anticipation that their shares in the company will grow and earn them dividends out of the company’s proceeds. Examples of equity financing are venture capital, angel investors, and private investors.
Conversely, debt funding is the provision of finances to be used in the company activities through borrowing money that needs to be repaid at a future date along with interest. The company does not lose any ownership to the lender, but it is obligated to pay the debt and the interest as and when due (Huang et al., 2016). The loan taken could be secured or unsecured, meaning that some loans require the company to use its assets as collateral(secured) while others do not need any collateral for the company (unsecured). This is an expensive means of raising business finances as it involves the structuring of the debt and repayment by a banker as well as interest rates. However, it is a feasible choice when the business returns are better, and the debt interest is low. Such sources include bank loans, equipment leasing, working capital loan, and SBA loans.
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Equity and debt financing differ in various aspects. While debt funding is borrowed and ought to be repaid after an agreed period, equity is owned by the company and can be kept for a long duration of time. Similarly, while debt financing creates creditors who are paid interest plus the borrowing, equity financing creates owners of the company who earn dividends as per their shares ( Corsi & Prencipe, 2018) . Debt financing carries minimal risk as the owner retains control over the company while equity financing has higher risks as investors become owners; thus, controlling power is shared. In addition, interest on debts are regular and fixed charges on profit while dividends on equity are often unfixed, irregular, and are appropriations of proceeds .
The key benefit of using equity financing is that it is less risky, and the company is not under any obligation to pay back the money invested. Moreover, a good network on investors helps to build the company’s credibility. Some investors and venture capitalists can add valuable skills, experience, and contacts to the company as they share a vested interest in the growth and profitability of the company ( Corsi & Prencipe, 2018) . On the other hand, debt financing can also be beneficial in that the company owner gets to control the business operation as the lender cannot dictate or have a say on how the company is run.
Both equity and debt financing are essential aspects in business funding. A company should carefully assess its credibility, business profitability, and ability to cope with shared control when deciding the source of finances. For firms using both financing methods, i t is crucial for them to maintain an equity fund that is twice as much the debt finance as only then the firms can be assumed to effectively cover their losses.
References
Huang, R., Ritter, J. R., & Zhang, D. (2016). Private equity firms’ reputational concerns and the costs of debt financing. Journal of financial and quantitative analysis , 51 (1), 29-54.
Corsi, C., & Prencipe, A. (2018). Internal funding, debt, and external equity: which of these effectively improve the growth of university spin-offs? International Journal of Entrepreneurial Venturing , 10 (6), 638-662.
