🏦capital-structure
Debt vs Equity Financing
Debt Financing vs Equity Financing
Debt means borrowing with fixed repayment obligations. Equity means selling ownership with no guaranteed payments.
Comparison Table
| Feature | Debt Financing | Equity Financing |
|---|---|---|
| Cost | Lower (tax-deductible interest) | Higher (equity risk premium) |
| Control | No ownership dilution | Dilutes existing ownership |
| Obligation | Fixed payments required | Dividends are discretionary |
| Bankruptcy risk | Increases financial distress risk | No mandatory payments |
| Tax effect | Interest is tax-deductible | Dividends are not deductible |
Key Differences
- →Debt has a tax advantage but increases bankruptcy risk
- →Equity is flexible but expensive and dilutive
- →The optimal mix minimizes WACC
When to Use Debt Financing
- ✓Stable cash flows to cover interest
- ✓Tax benefit is valuable
- ✓Maintaining ownership control
When to Use Equity Financing
- ✓Uncertain cash flows
- ✓Already highly leveraged
- ✓Need financial flexibility
Common Confusions
- !Thinking cheaper debt is always better (ignores distress costs)
- !Ignoring the dilution effect of new equity
FAQs
Common questions about this comparison
Usually equity, since startups have uncertain cash flows and may not be able to service debt.