Comparing Debt Financing and Equity Financing Essay

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There are two basic ways of financing for a business: Debt financing and equity financing. Debt financing is defined as 'borrowing money that is to be repaid over a period of time, usually with interest" (Financing Basics, 1). The lender does not gain any ownership in the business that is borrowing. Equity financing is described as "an exchange of money for a share of business ownership" (Financing Basics, 1). This form of financing allows the business to obtain funds without having to repay a specific amount of money at any particular time. There are also a few different instruments that could be defined as either debt or equity. One such instrument is stock options that an employee can exercise after so many years with the …show more content…
Now I will discuss the pros and cons of the alternative decision, which is a combination of the debt and equity methods. A positive of this method is that the instrument is split between debt and equity. The company could just split it up 50/50 between the two methods. Also if they had too much debt, they could account for the instrument with 20% as debt and 80% as equity. This would make it look as if they do not have too much debt or too much equity. This method would be an advantage, if the company were looking to get more financing in the future.

A negative aspect of this method is how the instrument is split between debt and equity. An example would be if the company split an instrument 50/50 between the two methods. This may seem fair when first accounting for it, but what if the split did not represent the actual split of the instrument. Let's say that it turns out that 90% of the instrument ends up being equity, and 10% ends up debt. The books would be off by quite a bit, and creditors my not be happy with the company when they learn of this.

Now that I have discussed pros and cons of each method, I will now explain the instrument that I will be using as an example. I will be using stock options as the instrument. Stock options are offered by many businesses to employees that stay with the company for a specified length of time. It is offered by the company as an
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