As debt and equity are the two most popular forms of raising capital for businesses, it is important to know the key differences between equity and debt funding and how they fit into the company’s goals and missions when considering capital for your startup.
There are unique advantages and drawbacks to both. Let’s take a closer look at the nature of equity and debt funding and their differences.
Understanding equity and debt
Equity funding is when businesses raise capital by selling ownership shares or equity. Investors not only get a share of the company’s profits but also a say in decision-making processes, often exercised through voting rights.
When investing against equity shares, investors are relatively more involved in the business operations of the company. They usually also get a slew of rights, including non-solicitation, pre-emptive rights, and information rights, among others.
Debt funding, on the other hand, refers to borrowing money from lenders with the promise of repaying them with interest, within a specified time. In this form of financing, the business and the source of the capital are bound by a contractual obligation with limited interference in the business’s day-to-day operations.
Ownership and control
In equity funding, founders give up a percentage of their ownership in the company which naturally reduces their autonomy over decision-making to a certain extent. The investors may exert influence over the company's strategic direction and operational decisions as well. While they share their expertise and views in the hopes of better business performance, too many opinions and viewpoints can often stifle growth.
As equity investors get a share in the profits, founders and early shareholders might end up getting less money in the end.
On the other hand, debt investors or lenders do not get involved in decision-making in the business, allowing greater freedom for entrepreneurs to run the venture as they wish.
Obligations
With external funding comes the obligations to funders. However, businesses are likely to have more obligations to fulfill when raising equity compared to debt.
As equity investors have more skin in the game in the business compared to debt investors, entrepreneurs are answerable to them regarding business growth or decline, key decisions in market expansion, strategy, product, and hiring, among others.
However, when startups raise debt, they are mainly only obligated to timely repayments of the loan as agreed at the time of raising debt and go on with business as usual.
Entrepreneurs must note that neither equity nor debt funding are not inherently good or bad, but the genius lies in how they are utilized according to the needs and stage of the business.
Make sure you understand the nuances of each funding method and carefully evaluate the implications of each option before deciding to raise the capital.
Visit LV Debt to learn more about raising pure-play debt for startups and emerging businesses.
Also Read:
The importance of debt in a changing startup funding environment
Five instances when debt is a good funding choice for startups
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