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 (Karjalainen, 2011).

Equity crowdfunding has become something of a legend in the startup industry (Hamlin, & Lyons, 2003). According to Karjalainen (2011), “It is being hailed (and criticized) for being a brand new conduit for startups to raise capital and for entrepreneurs to launch new endeavors. It’s true that a great amount of potential capital could be unlocked by including the non-accredited investors in the startup industry” (p. 4). Equity capital is capital that comes from the sale of stock to investors. Stock is an ownership interest in a corporation (Find Law, 2017). For example, “Lisa may form a corporation and issue 5,000 shares of stock and sell some of the shares to her friend for $100 per share. If she sells all 5,000 shares, she will have raised $500,000 in equity capital” (Investopedia, 2017).

When a firm finds that there are few investments in line, and their cash flows at the initial stage aren’t healthy, then in that case the firm would prefer equity financing (Find Law, 2017). Because at the end of the year, it won’t have any obligations to pay off the interest expense or any debt. When a firm finds that its intrinsic value is undervalued, then it starts issuing shares for gaining market sentiment, and ultimately increases its investor base. Moreover, when the interest rates for bonds go higher, the firms start relying more on equity financing and ultimately reduce the risk. At times, firms raise capital to deal with bankruptcy (Warren, & Dimovski, 2012). 

Warren, and Dimovski (2012) stated that: “Companies that raise investment capital throw equity can usually expect to deliver a return on investment through one of the following routes: Recapitalization, in which the company distributes dividends or cash to its stakeholders; a merger or acquisition, in which the company may be absorbed by or merged with its public equity investor, or sold for either cash or shares in another company by its private equity backers; a buyout, in which the equity investor agrees to pull out in exchange for a cash sum from the company, which thereupon regains its independence; or an initial public offering (IPO), whereby company shares are offered to the public on a stock exchange, which offers the equity investor both an immediate partial cash return on its investment, in addition to a public market in which additional share issues can be placed at a later date” (Warren, & Dimovski, 2012).

However, equity crowdfunding has brought a new way of presenting an entire capital raising pitch with a single website (IDBI bank raising of equity capital through QIP / FPO, 2014). Companies can maintain a profile, create engaging videos, access founder profiles, and use due diligence tools that potential investors can digest in a single, easy-to-comprehend page. The same information can be used to share key documents critical to the startup funding process such as term sheets and financial projections.

The days of attaching heavy emails and conducting lengthy phone calls to tell a simple story are slowly disappearing. Founders are becoming increasingly skilled at storytelling through a digital medium in a concise and meaningful fashion.

According to QFinance (2017), “Two out of five private equity funds are seeking monies from government/sovereign wealth funds. And 30% of the private equity funds surveyed are looking to qualified individual investors” (p. 5).

Moving beyond their own relationships with prospective investors, nearly 65% of private equity funds engage third-party marketers/placement agents. “Financial advisors are seen by 45% of those surveyed to be conduits to investors. Advisory professionals are important conduits to the high-net-worth market, confirms Grove. Once a person’s net worth exceeds a certain level, some form of professional advice is typically part of the equation whether it comes from a financial planner, an attorney, an accountant, a banker or some other specialist. The key is identifying who has real influence in the selection process. Only about 15% of the private equity funds believe conferences and other marketing events to be effective ways to connect with potential investors” (IDBI bank raising of equity capital through QIP / FPO, 2014). Meanwhile, advertising and social media are considered ineffective.

A startup that grows into a successful company will have several rounds of equity financing as it evolves. Since a startup typically attracts different types of investors at various stages of its evolution, it may use different equity instruments for its financing needs.

According to Find law (2017), “angel investors and venture capitalists, who are generally the first investors in a startup are inclined to favor convertible preferred shares rather than common equity in exchange for funding new companies since the former have greater upside potential and some downside protection” (p. 10). Once the company has grown large enough to consider going public, it may consider selling common equity to institutional and retail investors. Later on, if it needs additional capital, the company may go in for secondary equity financings such as a rights offering or an offering of equity units that includes warrants as a sweetener (Find Law, 2017).

Raising capital through equity can be a good choice for companies that are not ready for an IPO or are unwilling to finance expansion through debt. An equity deal means that the company has access to business experts through its investors, who can help to steer the business strategically as well as financially.

However, taking the equity route can lock a company into an agreement over a long time frame. The company may have to surrender a large stake in return for investment, possibly as much as 50%, and also provide seats on the board (Karjalainen, 2011). Investors may interfere with the company’s business plan and other areas of strategic importance (Ruhnka, 1985). With either type of equity deal, there needs to be chemistry between the counterparties. Lack of chemistry can lead to board disagreements and other problems, souring the relationship. It can be difficult for a company to extricate itself from an equity investment arrangement, depending on the terms of the deal.  

Debt capital is capital that has been raised through borrowing from a source outside the company (Jeon, & Kim, 2015). A debenture is an unsecured debt obligation, such as a promissory note or a corporate bond that a corporation offers to investors in exchange for a loan. Since debentures are not secured by any property, investors must rely upon the creditworthiness of the company to decide whether to loan money. Investors will receive interest as compensation for use of their money.

According to Hamlin, & Lyons (2003), “when the interest rate goes down, the firm starts issuing bonds or debentures for raising capital. To achieve the operating break-even point for effective use of debt. When a firm becomes matured it starts relying more on debt and reduces its cost of capital by incorporating more debt. For capital restructuring activities” (p. 10).

Debt capital, however, allows investors to keep all ownership in return for interest and principal payments (Dell’Erba, & Reinhardt, 2015). The major negative with debt capital is that your funding will come from banks or other lenders. These institutions look for low-risk investments, something that many start-up businesses cannot offer. Linked to that is the obligation to pay monthly interest on your loan which can be very difficult for businesses without established revenue streams.

Those businesses in the design or startup stage will have a harder time financing through debt because they cannot meet the immediate interest expenses. In other words, if you have no income because your product or service isn't finished yet, it is less likely for you to be funded by a bank (Czapinska, 2013). Most banks will ask for your old financial statements, more specifically for documents from the last three years. These documents allow the bank to evaluate how risky your business is and if you'll be able to make the monthly payments. Depending on your business's current position, this will either help ensure you a loan if you have healthy revenue streams or make funding through debt more difficult.

Most entrepreneurs have trouble with giving up partial ownership of their company, as is the case with equity financing (Pittman, 2016). They do not want the influence of others in their firm, and would rather put their own vision forward in order to grow the business (Grow Think, 2017). Thus, many entrepreneurs seek debt financing over equity financing (Grow Think, 2017).  

Hamlin, and Lyons (2003) stated that: “With a traditional loan, you can continue to run your company as you see fit. Venture capital requires you to meet an 'exit', or a return on investment for the venture capitalist that usually occurs in some form of acquisition of your company” (Hamlin, & Lyons, 2003). This will not be the case with debt capital, as there is no pressure from banks to meet a long-term exit strategy.

“When a company borrows money to finance its business operations through the sale of corporate bonds, the company agrees to repay investors' loans within a given time and makes interest payments to its investors as an incentive” (Hamlin, & Lyons, 2003). Some companies favor debt financing because loan interest payments are typically tax deductible and the company doesn’t dilute its ownership rights. On the other hand, investors favor investing in debt because it allows them to receive a fixed amount of income for a specified time period.

Any company with a poor credit rating will need to offer a high-interest rate to investors to obtain debt financing. In contrast, equity investors determine the value of a company by its historical and present financial performances (Pittman, 2016). According to Grow Think (2017), “Equity financing is a long-term venture, and the company does not control how long investors hold ownership rights within the business. Some investors hold on to a company’s shares for many years. Debt financing terms can vary in length. Some companies choose to issue bonds for five years, while others issue 30-year bonds” (p. 8). Once the money is repaid, the relationship between the company and the investor is over. 

The advantages of Debt Compared to Equity are important because the lender does not have a claim to equity in the business, and debt does not dilute the owner's ownership interest in the company. A lender is entitled only to the repayment of the agreed-upon principal of the loan plus interest and has no direct claim on future profits of the business (Price, 2016). 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 that 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” (Pittman, 2016). 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.

According to Czapinska (2013), “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” (p. 12). 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 (Hamlin, & Lyons, 2003). 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” (Hamlin, & Lyons, 2003).

Compared to debt financing, equity financing is considered less risky. A new company may find it challenging to repay its debt obligations, especially during economic downturns and rising interest rates. Although less risky, equity financing also comes with risks. Shareholders who gain majority control in a business can influence major operational decisions within the company. 

References

Arner, D. W. (2006). Asia's debt capital markets: Prospects and strategies for development. New York: Springer. Czapinska, K. (2013). The role of debt capital in corporate financing--overview of selected surveys. E-Finanse, 9(3), 11-23. Dell'Erba, S., & Reinhardt, D. (2015). FDI, debt and capital controls. Journal of International Money and Finance, 58, 29-50. doi:10.1016/j.jimonfin.2015.07.017 Find Law (2017). Debt vs. Equity -- Advantages and Disadvantages. Retrieved from http://smallbusiness.findlaw.com/business-finances/debt-vs-equity-advantages-anddisadvantages.html/ Grow Think (2017). Debt Financing For Your Business: The Pros & Cons. Retrieved from https://www.growthink.com/capital-raising/loans/Debt_Financing_For_Your_Business Hamlin, R. E., & Lyons, T. S. (2003). Financing small business in america: Debt capital in a global economy. Westport, Conn: Praeger. IDBI bank raising of equity capital through QIP / FPO. (2014, ). Premium Banking News Investopedia (2017). Equity Financing. Retrieved from http://www.investopedia.com/terms/e/equityfinancing.asp 

Karjalainen, J. (2011). Audit quality and cost of debt capital for private firms: Evidence from finland: Audit quality and cost of debt capital for private firms: Evidence from finland. International Journal of Auditing, 15(1), 88-108. doi:10.1111/j.1099-1123.2010.00424.x Markram, B. (2004). A tarnished image: Equity investors are keeping insurance and reinsurance stocks at arm's length because of the industry's consistent poor performance. this is making capital raising through equity potentially difficult for companies. on the other hand, it seems investors cannot get enough of insurance debt issues Euromoney Trading Limited. Pittman, J. A., & Fortin, S. (2004). Auditor choice and the cost of debt capital for newly public firms. Journal of Accounting and Economics, 37(1), 113-136. doi:10.1016/j.jacceco.2003.06.005