equity or debt which is better



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often confusing

4 Answer(s)


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Well I think it really depends on quite a few factors,
1. No obligation to pay dividends.
Raising money through equity doesn't make the company liable to pay dividends to its stakeholders, it may decide to add the profits to the reserves. In case of debt there is always some interest that the company will have to pay. So in this case equity is better.
2. Ease to raise debt or equity.
On this front it gets all relative and a lot depends on the perception of the stakeholder you are dealing with. In case you want to raise debt you need to have strong free cash flow. This is one of the most important factor among other things. So if the company needs funds and can service the debt well, raising debt could be a good option.
In case of equity the important factors for the stakeholder would be the business idea, the sector, the long term goals etc. The stakeholder could be lenient on the FCF as at its not about the cash flow for the stakeholder here. He could be looking at good valuation for his shares and may come with an exit plan too like most VC's do.
Depending on the situation, the company on can take a call on what could be better. For eg. A start up would most probably raise money by giving away some share in the company to some investor by pitching him/her the idea. They wont be having promising picture when it comes to cash flow, at this early stage.
3. Personal choice of the founder.
If the founders are keen to keep 100% control, over the company, with themselves they would try to raise debt.
4. Tax implication.
Interest is an expense before the tax is calculated. It gets your profits down and thus the tax too. Whereas dividend is not an expense (even though the company will have to part away with its profits). Thus there wont be any benefit here.

I will add to the answer later if I am able to think of anything more or if I have missed any point :)

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In short debt is better than equity if company is a start up. For companies in need of capital to grow, debt is better since it’s cheaper form of financing than equity. Suppose we take a loan for a period of time, we either pay interest over the life of the loan, or pay it fully. whereas in case of equity it is considered expensive since we are selling shares and the equity buyers may hold such shares into perpetuity. Debt is thus a cleaner structure, and assuming we can put the loan to work in a way that generates a higher return than the interest you pay, debt is typically the preferred way to finance growth.

I hope I made it clear.

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Debt is better

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from cost perspective,equity financing is costly. so in long term debt financing is better.