Debt vs. Equity

There are two basic choices for financing – debt or equity. Debt is borrowed money usually secured with collateral. Equity, on the other hand, is contributed capital in exchange for the company’s ownership share. Both have pros and cons. Debt transaction does not dilute equity, but there is a legal obligation to return the money. Equity grants dilute the ownership in the company, but if business does not live up to the expectations, there is no need to return the investment; everyone will be in the same boat. Most startups during their lifetimes do both.

 

It is important to think about the methods of financing strategically. Some entrepreneurs may prefer to take debt at the initial stages of business development and save equity for future rounds of financing, when a company is ready for venture funding. Others may not be in a position to take the risk with secured debt or may need to attract talent for their business development and do not have spare funds to compensate the employees. Then equity compensation may be helpful. As types of businesses vary greatly so is the type of financing which may be appropriate for each.

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