Most businesses try to finance expansions at least in part by reinvestment profits from ongoing operations. All businesses must have financing from outside sources when they first begin operations, and businesses need additional financing at certain points in their growth. These outside funds may come from equity and debt financing. In order to expand, it is necessary for business owners to tap financial resources. Business owners can utilize a variety of financing resources, initially broken into two categories, debt and equity. "Debt" involves borrowing money to be repaid, plus interest. "Equity" involves raising money by selling interests in the company. Both equity financing and debt financing have favorable and unfavorable factors. The following table discusses the advantages and disadvantages of debt financing as compared to equity financing.

Advantages of Debt Financing:

Debt financing allows you to pay for new buildings, equipment and other assets used to grow your business before you earn the necessary funds. This can be a great way to pursue an aggressive growth strategy, especially if you have access to low interest rates. Closely related is the advantage of paying off your debt in installments over a period of time. Relative to equity financing, you also benefit by not relinquishing any ownership or control of the business.

1. Interest payment reduces the cost of fund.

2. It is unnecessary to set aside large amount of cash for peak needs.

3. No sharing of ownership of control is required by others.

4. Better leverage and higher rate profit.

5. Because the lender does not have a claim to equity in the business, debt does not dilute the owner's ownership interest in the company.

6. A lender is entitled only to repayment of the agreed-upon principal of the loan plus interest, and has no direct claim on future profits of the business. If the company is successful, the owners reap a larger portion of the rewards than they would if they had sold stock in the company to investors in order to finance the growth.

7. Except in the case of variable rate loans, principal and interest obligations are known amounts which can be forecasted and planned for.

8. Interest on the debt can be deducted on the company's tax return, lowering the actual cost of    the loan to the company.

9. Raising debt capital is less complicated because the company is not required to comply with state and federal securities laws and regulations.

10. The company is not required to send periodic mailings to large numbers of investors, hold periodic meetings of shareholders, and seek the vote of shareholders before taking certain actions.

11. Short term debt financing is a source of 'quick' liquidity for the business, in particular SMEs, who do not have large pool of reserve funds for emergency uses.

12. Small enterprises are more prone to short term shocks from their operating environment such as a large debtor declaring bankrupt, or an abruptly ceased partnership with a major supplier.

13. Short term debt financing is usually easier to negotiate (compared to long term debts and equity financing), as the financier faces relatively lower credit risk.

14. Most short term debt financing instruments can be obtained without having to pledge a considerable amount of collateral, as long as the borrowing company has relatively stable operations and turnover rate (i.e. moderate business risk).

15. The cost of servicing short-term credit is less taxing on the company. Short-term loans usually offer lower interest charges, and most suppliers do not charge interest at all until the credit allowance period is breached.

16. Long term debt financing is usually less prone to short term shocks as it is secured by formally established contractual terms. Hence, they are relatively more stable than short-term debt.

17. Long term debt financing is directly linked to the growth of the company's operating capacity (purchase of capital assets such as machinery).

18. Long-term debt is normally well structured and defined. Thus fewer resources have to be channeled to monitor and maintain long-term debt financing accounts

19. Long-term debt financing options such as leases offer a certain degree of flexibility, compared to having to purchase the asset (E.g. machinery).

Disadvantages of Debt Financing:

The most obvious disadvantage of debt financing is that you have to repay the loan, plus interest. Failure to do so exposes your property and assets to repossession by the bank. Debt financing is also borrowing against future earnings. This means that instead of using all future profits to grow the business or to pay owners, you have to allocate a portion to debt payments. Overuse of debt can severely limit future cash flow and stifle growth.

1. It may not be always available.

2. It may call for higher rate of interest.

3. It may encounter unfavorable terms and conditions.

4. Profit is reduced by payment of interests and loan installments.

5. Unlike equity, debt must at some point be repaid.

6. Interest is a fixed cost which raises the company's break-even point. High interest costs during difficult financial periods can increase the risk of insolvency.

7. Cash flow is required for both principal and interest payments and must be budgeted for. Most loans are not repayable in varying amounts over time based on the business cycles of the company.

8. Debt instruments often contain restrictions on the company's activities, preventing management from pursuing alternative financing options and non-core business opportunities.

9. The larger a company's debt-equity ratio, the more risky the company is considered by lenders and investors. Accordingly, a business is limited as to the amount of debt it can carry.

10. The company is usually required to pledge assets of the company to the lender as collateral, and owners of the company are in some cases required to personally guarantee repayment of the loan.

11. Short term debt financing has to be monitored closely to avoid bad relationships with suppliers and bankers, or a bad reputation in the industry for not paying debts on time.

12. Long term debt is often costly to service (interest charges are higher).

13. Long-term debt financing contracts normally contain a lot of restrictive clauses and covenants.

Advantages of Equity Financing:

Equity financing doesn't have to be repaid. Plus, you share the risks and liabilities of company ownership with the new investors. Since you don't have to make debt payments, you can use the cash flow generated to further grow the company or to diversify into other areas. Maintaining a low debt-to-equity ratio also puts you in a better position to get a loan in the future when needed.


1. No interest charges are required to be paid.

2. Solvency is less likely to be threatened.

3. Profits are not reduced by loan repayments.

4. The major advantage of taking the route of equity to raise funds for the business is that the promoter is not bound to repay any amount. The investor buys a portion of the company, and gets the proportionate share of the profits or loss.

5. Since investors share profits and loss, equity financing protects the company during times of economic downturn and limits the promoter’s loss. A public listed company is a separate entity distinct from its promoter.

6. The involvement of many investors or a high equity base improves the credit rating of the company, for this gives the impression of a venture backed by many investors.

7. The presence of ever-watching investors keeps the management of the company on their toes to perform at their best.

8. The law requires public listed companies to maintain impeccable records, hold regular general body and director meetings, audit their accounts, and follow other standard practices.

9. Raising money through equity by listing in the stock exchange makes it easy for the promoter to offload his holdings to any other interested investor and quit the company without closing down the business.
Disadvantages of Equity Financing:
By taking on equity investment, you give up partial ownership and, in turn, some level of decision-making authority over your business. Large equity investors often insist on placing representatives on company boards or in executive positions. If your business takes off, you have to share a portion of your earnings with the equity investor. Over time, distribution of profits to other owners may exceed what you would have repaid on a loan.


1. If requirements decreased invested money may remain idle.

2. A greater total investment reduces the return on investment.

3. Sharing of ownership of control is required by others.

4. While raising equity is a good way to exit the business, it becomes difficult for the interested promoter to retain control of the business.

5. If the promoter does not match the investments made by other investors, there is a chance of other investors acquiring more than 51 percent of the company shares and taking control of the company, forcing the promoter out.

6. The strict adherence to rules and regulations, holding of meetings, filing reports and the like increase the standards of corporate governance but also takes up valuable time, energy, and resources that could be best spend in improving the company core process.

7. While profit and loss sharing protects the company during bad economic times and difficult cash flow periods, it also leads to a higher outgo to the investors during good economic times. The profit sharing in is proportion to the investment made by each investor.

8. Taking in investors is a permanent obligation, and the investors have a right to stay put and take their cut of profits forever. This is in contrary to debt financing when all obligations end when the loan plus interest is repaid in full.

Most businesses try to strike a balance between equity and debt financing. The ratio of borrowed assets to owned assets, or debt ratio, is another meaning of leverage.