Debt or equity financing: What’s right for my business?


Find the capital that fits best for you

There’s no shortage of options when it comes to finding capital to fuel your business’s growth. Your choice will depend on your company’s cash flow, income, business risk, and ownership. That’s why it’s important to us to help you understand your options.

The two most common options are debt financing or an equity infusion from investors. But which option should you consider: Debt or equity financing? Each choice has distinct advantages and drawbacks—both short- and long-term.

Debt financing and equity infusion have very different effects on your balance sheet, income, cash flow, and taxes.

If your company boasts healthy numbers and cash flow, you’ll find plenty of debt financing available at competitively low rates. You’ll repay the business loan under specific terms regardless of your company’s performance or prevailing economic conditions.

Equity financing allows you to exchange a percentage of your company’s holdings to raise business capital. You’ll share profits, ownership, and some control over operations and long-term strategy.

Optimal capital structure for larger companies typically involves a mix of both debt and equity financing, which may fluctuate over time.

Get to know the benefits and drawbacks of debt and equity financing before seeking capital for your business.

Understand each type of financing

Get to know the benefits and drawbacks of debt and equity financing before seeking capital for your business.

Types of financing
Debt Equity
  • Tax-deductible interest with reduced capital cost
  • Dividends paid out of after-tax profits
  • Dilution of ownership and share of business value created
Transaction fees
  • Closing fees and ongoing fees that vary by type of loan
  • Placement fees and other fees that vary by type of equity
  • Thorough application process
  • Working relationship with a single lender or lead syndicate banker
  • Extensive senior management meetings and time in securing equity
  • Compliance with federal securities laws and regulations
  • Ongoing investor management with mailings, meetings, and approvals
  • Limited control if payments are current, and covenants are met
  • Investor board participation and approval of strategy/capital decisions
  • Escalated participation to protect investment
  • Potential for challenge to seek full company control
Return of capital
  • Favored position for repayment of borrowed capital
  • Loss of collateral or business assets like cash, equipment, receivables, and owner personal assets in the event of default
  • Subordinate position in return of capital
  • Leverage over future capital infusions and returns

What is debt financing?

Simply put, debt financing is when you take on debt to put money into your business.

An example of this is a commercial bank loan, in which you borrow money from a bank and then pay the loan back over time, with interest. You’ll likely need collateral to get this type of loan, such as property or equipment.

Another example of debt financing is merchant cash advances. With this type of loan, you repay using the money you get from your business’s debit and credit card sales. This type of loan can come with costly interest rates, but it’s a fast way to infuse cash into your business when you don’t have much collateral.

There are also revolving loans and business credit cards, which are lines of credit you use when you need to.

The advantage of debt financing is that your lender won’t have any control over your business. (And the interest you pay is tax-deductible.)

The only disadvantage is that you have to qualify—and you also have to be sure you can repay the loan, which will be more expensive when interest rates are high.

What is equity financing?

With equity financing, you sell a part of your business to infuse capital into your business. It’s an option if you have trouble getting a traditional loan or don’t want to incur any more business debt.

One way to get equity financing is through one investor, who buys a stake in your company. These are sometimes called angel investors.

Another option is to get equity financing using venture capital, which comes from a person or a group that invests in businesses they see as having high growth potential.

You could also explore equity crowdfunding, which is raising funds from many people who invest small amounts.

The good news is when you choose this option, there’s nothing to pay back and no interest rate to worry about. But once someone has bought a stake in your business, they have a say in how it’s run—and you have to share your profits with the investor.

Is the lower cost of debt worth the default risks if repayments can’t be made? And is equity flexibility worth giving up part of the business? Talk to your bankers, advisors, and management team about the source that fits best with your next capital raise.

Is debt or equity cheaper?

The common knowledge is that debt is usually cheaper than equity, given that you can take a tax deduction on your interest payments and that lenders expect lower returns than investors would.1

But it also depends on how your business is doing now, and how you’re estimating your future profits. If a business ends up going under, then equity financing would have been cheaper. But if you borrow money and your business closes, you still need to repay the loan, even though you are no longer getting any income from that business.

Experts predict that it will become increasingly difficult to find willing investors. Or if they are willing, they might ask for a larger stake in your business than before, so choosing equity might be a challenge.2

Change your debt-to-equity mix.

What if you need more capital or want to access some of the value tied up in the company’s equity? There are several ways to go about it. Start with these fundamental questions:

  • What’s your growth strategy—organic or acquisition?
  • What are your liquidity needs?
  • Do you have cash flow issues (inflated accounts receivable, seasonal fluctuations)?
  • What’s your current ownership structure and succession strategy?
  • Are you willing to trade equity for capital?

Outlining your capital strategy will also shed some light on your ambitions.

If you’ve got a fully committed balance sheet, your capacity for additional acquisitions will be limited. Your willingness or reluctance to relinquish ownership of your business will determine if an equity solution can be used for additional capital beyond your capacity for debt financing.

Equity buyback

You may be able to change your company’s equity-to-debt balance. If your business relinquished capital during a startup or growth phase, you can reclaim or even recapitalize that equity through debt financing.

A direct seller and marketer of natural food supplements secured $130 million in credit with our help to buy back a significant portion of the equity it had previously sold to a private equity firm while also gaining access to additional working capital.

Debt refinancing

Use debt to refinance capital at a better interest rate. Be sure to monitor the interest rates of your existing loans and lines of credit. Keep in mind that lowering your company’s overall debt servicing costs makes it easier to obtain additional capital in the future.

Adding debt

Startup businesses aren’t usually well-suited for the fixed payments required by most debt obligations. Early-stage capital is often tied to equity, but it doesn’t have to stay that way. When cash flow predictability increases as your business matures, you may want to consider shifting more debt to your capital mix. Your company can trade debt for owner equity or use it to help fund your next capital raise.

Reducing debt

In later phases, your business may experience cash flow issues due to the high cost of debt servicing. This is typical of any highly leveraged company with a large debt-to-equity ratio. Your business will be seen as a risk, which will make adding debt more expensive. Raising more equity or using cash flow to retire debt can help get your company’s capital mix back in line.

Ready to fund your company’s next phase?

Talk to your Truist relationship manager about creative and innovative strategies to finance your growth.