If you have a need for cash then you may be wondering what the difference is between debt vs. equity financing. Well, if you are borrowing money, say on a credit card, that is debt. There is nothing to back it except the fact that you have a good record for paying enough to satisfy the creditor, the credit card company every month.
Equity financing is as it implies, based upon equity you have built up in your own investment holdings. The best example of this is a house that is worth $500,000 where the homeowner only owes $200,000 on the mortgage. It means there is $300,000 equity available to gain some capital for other investments and life.
While it is not considered wise to spend your own personal funds, use your own personal credit card, or to mortgage your very own home on a business venture, the home equity line of credit is an option for producing cash.
What Does Debt Vs. Equity Mean In Business?
For business owners, a common way to produce much-needed money is by finding investment capital. It may not create debt like the example of the credit card up above, but it does mean that the business will have to do a few things that can be costly.
First off, the business will have to share profits with its investors. That’s not a big deal if the cash fusion makes hundreds of millions of dollars in profit appear. It is an issue if the business barely is able to charge enough because of downward pricing pressures.
Additionally, once investment capital comes into play, it means that not only is the company having to deal with the added business expenses to keep the corporate renewal up to date, along with a valid business license, but now the business has to file Form-D with the Securities And Exchange Commission for every state from which there are investors.
It costs $500 per filing of this form. Add to this that there are home-state filings and there now there is the addition of a securities lawyer who needs to be added to the company payroll.
Now a loan is more risky as it needs to be paid back and carries an added negative weight of interest on top of the primary balance. The trouble with a loan or even a business credit card is that if the money is not available to repay the loan it actually puts the company into a precarious financial situation.
So, instead of rescuing the company the debt ends up being like an anchor that may drown the company. There is perhaps equity in a business that can provide equity, such as an office building that the business owner owns to operate their company.
If there is a slow period, and other companies occupying the space who can pay rent, then an equity loan is not a terrible deal. There are many times a business needs cash and has to rely upon short-term or bridge loans, equity, and investor capital to keep it going.