Businesses need money to run or expand their existing business or start a new business. They mainly take two routes to fund the requirements equity financing and debt financing. Some companies facing a shortage of funds also use the commercial mortgage route to fund their needs.
Equity financing- Equity financing involves raising the capital required in exchange for the business ownership interest. This stake is offered in the form of shares and can be offered either through public issue route to the general public or through the private placement route to private / institutional investors.
Debt Financing- When a company borrows money from an external source and promises to return the money together with an agreed interest within a specified time, it is said to have taken a debt to finance its business needs.
Comparison between debt and equity financing
The main differences are related to the surrender of the ownership stake and the amount of risk involved. In the case of debt financing where there is no surrender of ownership stake, there is a higher risk for the business in the event of non-payment of the debt as the lenders may legally impound business critical assets.
Debt financing options
Fixed-Income Securities - A company that seeks to raise money through the debt route provides securities with a certain amount of interest. After a certain period of time, these securities are repayable. In essence, people who buy these securities extend a loan to the issuing company.
Loans - Banks or private lenders borrow money from businesses. Some kind of security, also known as collateral, may or may not support this kind of debt. The loan is called an unsecured loan if there is no collateral. Also known as commercial mortgages are secured loans.
Commercial mortgages -A loan is extended with commercial mortgages against a business asset that can be repaid in the form of instalments over a period of time. The installments consist of a portion of principal and interest. In the event of non-payment of installments, lenders may seize and sell the asset in order to recover the amount loaned.