Can you give advantages and two disadvantages of debt finance over equity from the company's viewpoint?

In order to expand, it's necessary for business owners to tap financial resources. Business owners can utilize a variety of financing resources, initially broken into two categories, debt and equity. "Debt" involves borrowing money to be repaid, plus interest, while "equity" involves raising money by selling interests in the company.

Essentially you will have to decide whether you want to pay back a loan or give shareholders stock in your company. The following table discusses the advantages and disadvantages of debt financing as compared to equity financing. -

Advantages of Debt Compared to Equity :

* Because the lender does not have a claim to equity in the business, debt does not dilute the owner's ownership interest in the company.

* A lender is entitled only to repayment of the agreed-upon principal of the loan plus interest, and has no direct claim on future profits of the business. If the company is successful, the owners reap a larger portion of the rewards than they would if they had sold stock in the company to investors in order to finance the growth.

* Except in the case of variable rate loans, principal and interest obligations are known amounts which can be forecasted and planned for.

*  Interest on the debt can be deducted on the company's tax return, lowering the actual cost of the loan to the company.

*  Raising debt capital is less complicated because the company is not required to comply with state and federal securities laws and regulations.

* The company is not required to send periodic mailings to large numbers of investors, hold periodic meetings of shareholders, and seek the vote of shareholders before taking certain actions.

Disadvantages of Debt Compared to Equity :

* Unlike equity, debt must at some point be repaid.

*  Interest is a fixed cost which raises the company's break-even point. High interest costs during difficult financial periods can increase the risk of insolvency. Companies that are too highly leveraged (that have large amounts of debt as compared to equity) often find it difficult to grow because of the high cost of servicing the debt.

 * Cash flow is required for both principal and interest payments and must be budgeted for. Most loans are not repayable in varying amounts over time based on the business cycles of the company.

*  Debt instruments often contain restrictions on the company's activities, preventing management from pursuing alternative financing options and non-core business opportunities.

*  The larger a company's debt-equity ratio, the more risky the company is considered by lenders and investors. Accordingly, a business is limited as to the amount of debt it can carry.

* The company is usually required to pledge assets of the company to the lender as collateral, and owners of the company are in some cases required to personally guarantee repayment of the loan.

Advantages:

- Its cheaper than equity financing because of tax savings on interest cost.

- Its availability is easy as compared to equity financing

Disadvantages:

- Company have to meet certain financial covenants which they didn't have to in case of equity financing

- They must have to pay interest and principal as per schedule whatever the Company's financial position be, however in case of equity financing if you are in losses you have no obligation to pay dividends

• Debt advantage refers to, financing which allows you to pay for new buildings, equipment and other assets used to grow your business before you earn the necessary funds
• also,This can be a great way to pursue an aggressive growth strategy.

now advantage of equity as in,

• Equity financing doesn't have to be repaid. Plus, you share the risks and liabilities of company ownership with the new investors.

lets talk about disadvantages of both the factors,

 

1. Debt disadvantage,
   • The most obvious disadvantage of debt financing is that you have to repay the loan, plus interest. Failure to do so exposes your property and assets to repossession by the bank
2. Equity disadvantage,
   • By taking on equity investment, you give up partial ownership and, in turn, some level of decision-making authority over your business

The advantages of raising finance by issue of debentures are :- 1. The cost of debentures is much lower than the cost of equity capital as the interest is tax deductible. Investor consider debentures investment safer than equity investment and hence may require lower return on debentures investment. 2. Debentures financing does not result in dilution of control from the company point of view. The dis advantages of debentures financing are :- 1. Debentures interest and capital employment are obligatory payment. 2. Debentures financing enhances the financial risk associated with the firm.