Equity financing often means issuing additional shares of common stock to an investor. With more shares of common stock issued and outstanding, the previous stockholders’ percentage of ownership decreases.
Debt financing means borrowing money and not giving up ownership. Debt financing often comes with strict conditions or covenants in addition to having to pay interest and principal at specified dates. Failure to meet the debt requirements will result in severe consequences. In the U.S. the interest on debt is a deductible expense when computing taxable income. This means that the effective interest cost is less than the stated interest if the company is profitable. Adding too much debt will increase the company’s future cost of borrowing money and it adds risk for the company.
You can learn more about equity financing under Stockholders’ Equity. You can learn more about debt financing under Bonds Payable.
About the Author: Harold Averkamp (CPA) has worked as an accountant, consultant, and university accounting instructor for more than 25 years.
He is the author of the 2010 Master Accounting Download Package which has been praised for it's ability to simplify accounting in a way that anybody can understand.
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