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Debt vs Equity: What's the Difference?

When it comes to financing a business, there are two main options: debt and equity. But what's the difference between the two? Here's a look at the key distinctions between debt and equity.

What is Debt?

Debt is a loan that must be repaid, with interest. The most common type of debt financing for businesses is a bank loan. Other types of debt financing include lines of credit, bonds, and merchant cash advances. With debt financing, the lender takes on the risk of the loan, while the borrower receives the funds they need with the obligation to repay the loan.

What is Equity?

Equity financing is when a business raises money by selling ownership stakes in the company. The most common type of equity financing is venture capital. In this type of financing, a venture capitalist invests money in a company in exchange for equity. Other types of equity financing include angel investors, initial public offerings (IPOs), and convertible debt.

Key Differences Between Debt and Equity

Now that you know the basics of debt and equity financing, let's take a closer look at the key differences between the two:

  • Risk: With debt financing, the lender takes on the risk of the loan. With equity financing, the investor takes on the risk of the investment.
  • Control: With debt financing, the borrower retains control of the business. With equity financing, the investor receives a say in how the business is run.
  • Cost: Debt financing is typically less expensive than equity financing. This is because the interest on a loan is tax-deductible, while the dividends paid to shareholders are not.
  • Repayment: With debt financing, the borrower is obligated to repay the loan, with interest. With equity financing, the investor does not expect to receive a return on their investment until the company is sold or goes public.

Now that you know the key differences between debt and equity financing, you can decide which option is right for your business.

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