Evaluation Of Debt And Equity Funding

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Evaluation of Debt and Equity Funding
There are two ways for a company to raise funds: debt financing and equity financing.
Debt financing
Debt financing is a way of raising capital by ‘selling bonds, bills, or notes to individual or institutional investors with a promise of repaying principal and interest on the debt’ (Investopedia 2015a). One of the greatest advantages of debt financing is that the debtor has full control of the borrowed capital and does not need to relinquish any ownership of the business as compensation to the lender (Kokemuller n.d.). At the same time, debt financing optimizes ownership structure and avoids conflict between the owner and shareholders. In addition, the fact that the business starts up with debt could be incentive for the managers to make careful decisions, for they have to avoid taking risks as a debtor.
The downside of debt financing is that there are larger amount of fixed expenses of the loan and interest, which would possibly become a burden for the business if it were not developing well. As the debt could be treated as ‘a bet on your future ability to pay back the loan’ (Parker 2012), the company has to take the risk of bankruptcy if it couldn’t afford the loan. Furthermore, the credit-worthiness of the company would have to be evaluated by the bank when borrowing money. Thus high credit risk might be a drawback for small business if the owner intends to take a large amount of loan.
Equity financing
Equity financing refers to

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