Georgia Institute of Technology Debt Financing Discussion

There are many ways in which a growing venture can raise money.  What are the advantages and disadvantages of debt financing as opposed to equity financing?

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The biggest difference between debt financing and equity financing is debt financing is funding given as a loan with an interest rate attached and must be paid back with the terms given. Equity financing involves funding that includes ownership within the business to help offset the risk with reward should the investment in the business pay off with increased growth for the business. 

Debt financing is typically done by a traditional bank or lender. Business financials are analyzed to ensure cash flow can support a repayment period of the borrowed amount. The lender charges interest on the loan to compensate for the risk and make revenue in financing the business. In general debt financing usually isn’t able to provide enough funds for substantial growth. Debt financing is also stringent on the business financials to approve funding which can hamper the amount a business can borrow. 

Equity financing is typically done by a venture capitalist or other investor. Equity financing trades funding for an ownership stake in the venture. Equity financing usually involves larger amounts of funding that are able to fund growth but founders must trade a share of ownership. The ownership share is how equity financiers make money when the business grows. The disadvantage is giving up a piece of the ownership stake but the advantage is being able to obtain the funding needed to grow. 

New ventures usually go through a period of bootstrapping, then traditional debt financing and finally equity financing to fund growth. The bootstrapping period proves the business model to allow for traditional debt financing which helps increase to the business valuation before moving into equity financing. This helps reduce the financial impact of equity financing requiring an ownership stake. Although this is typical, some ventures need to move into equity financing sooner due to the complexity of their offerings and market demand. Ultimately, founders need to choose the appropriate types of financing to achieve their strategic milestones for growth.