Debt Financing

Borrowed capital vs. own capital -- pros and cons

Entrepreneurs need to access finance in order to grow. Businessmen can use a wide range of financing sources, divided into two initial groups, debt and own capital. "Liabilities " includes the proceeds of principal repayments plus interest, while "equity" includes the proceeds of the sale of shares in the Group.

In essence, you have to choose whether you want to repay a mortgage or give your shares to your company's stockholders. In the following chart, the pros and cons of debt financing are shown in comparison to debt financing. As the creditor is not entitled to the entity's own funds, liabilities do not water down the owner's interest in the entity.

Lenders are only eligible for reimbursement of the debt plus interest and are not directly eligible for the company's prospective earnings. Once the firm is a success, the owner reaps a greater share of the profit than if he had been selling the firm's shares to an investor to fund it.

The interest on the debt can be subtracted from the company's income statement, which reduces the real costs of the credit to the business. Borrowing is less complex as the firm is not obliged to abide by state and provincial legislation and regulation on transferable assets. There is no obligation for the entity to regularly mail to a large number of depositors, convene shareholder conventions and obtain shareholder votes before taking certain action.

In contrast to own capital, debts have to be paid back at some point. A high interest rate in challenging business hours can raise the probability of bankruptcy. Enterprises that are too heavily debt-financed (which have large debts relative to equity) often find it hard to expand because the debt service charges are high.

Cashflow is needed for both capital and interest repayments and must be budgetised. The majority of mortgages are not redeemable in different installments over the course of a period of time, depending on the enterprise's operating cycle. Debenture securities often contain limitations on the Company's operations and prevent senior managers from seeking alternate financing and noncore businesses.

As a result, the greater the leverage of a firm, the more risk it faces from creditors and financiers. Accordingly, a firm is restricted in the amount of debt it can bear. Usually, the entity is obligated to pawn corporate property to the creditor as security, and the owner of the entity is in some cases obligated to ensure personal repayments of the loans.

Whether you want to fund your new enterprise through credit or shareholder participation is a serious issue and you should fully comprehend your choices before making this one. Spending on advice from a qualified commercial lawyer can now help you safe much, much more along the way.

Turn to a skilled commercial lawyer to help you tackle the financial issues important to your company.