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Debt Financing and Equity Borrowing’ Comparison Essay

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Updated: May 28th, 2020

Introduction

When one intends to start a business, one should focus on how to raise capital and raise money to finance the business operations. Today, many commercial lenders charge differential interest rates for the money borrowed. Some local and international companies specialize in investing in businesses. Such companies have some set rules that allow it to run its plans and enhance mutual understanding. Other logistics like the human power and the business operations should be studied before the parties engage in business. Other factors that should be considered before deciding on debt financing or equity borrowing is the tax situation in the country of interest, the business plan and potential investors (Sawyer and Sprinkle, 2009).

Discussion

The equity financing is fundamental in ensuring that a person interested in starting a business does not have burden of huge loans on him/her. The business start-up loan depends on the nature of business, the location of the business, the size of the business and the price of goods in the market. A person who intends on starting a business should always do a budget of all his business plans to ensure that he/she has a working figure that can allow effective planning (Sawyer and Sprinkle, 2009). On the other hand, loan repayment can be difficult because of high interest and increased cost of life; thus, equity investing allows a businessperson be free of settling loans that have high interest loans (Kenen, 1964, p.51).

Additionally, equity financing allows the two parties to engage in a business that is well-defined by the set rules. For example, when a businessperson drafts a prospectus that discusses issues like losses and profit, the investor can understand when the business plunges in losses. This is from the fact that business investors understand from the start that a business either can blossom or fail. It is always obvious that commercial lenders and some relatives would expect to be repaid back their loan whether the business does well of fails. Thus, borrowing from commercial lenders such as banks can be riskier compared to selling some shares to an investor. It is essential to state that commercial lenders always ask for security like personal properties like title deeds, vehicles and other assets. It is evident that when a debt-financed business fails, the businessperson will loose his/her properties.

Borrowing in the form of equity also allows the businessperson to choose whom he/she is interested in working with and financing the business. The businessperson can visit many investors and choose the investor he/she is comfortable to work with. It is fundamental that the businessperson chooses the investor wisely as this will define the business operations. Some investors have stringent terms that can strain the businessperson; hence, equity financing allows the businessperson choose his/her team player wisely. In most cases, borrowing in form of debt does not offer the businessperson with many options. According to Sawyer and Sprinkle, the commercial lenders are some lobby groups that have special interest; hence, they benefit themselves. They do not necessarily have the interest of the business; rather, they focus on what they can benefit from the trade partnership (Sawyer and Sprinkle, 2009).

In addition, equity financing is always guided by governmental and international policies that guide the two partners. These policies determine how businesses operate, the tariffs, the trade barriers and other factors that relate to trade. The economic sanctions guide in ensuring that trade partner follows the set rules to the latter. These sanctions are laid down by the two partners and agreed upon so that any deviance can be punished accordingly. This ensures full participation and commitment by the equity investor; thus, promoting the smooth running of trade between them. Additionally, equity financing is advantageous because the government policies ensure that certain issues pertaining the business or trade are sorted. For example, in case there is market failure, which affects the trade performance, the governments through its arms of economic regulations can intervene. This ensures that partners do not plunge in losses that can lead to trade reduction or business failures. On the other hand, the government policy applies to debt financing to some small extent. In essence, the lender determines most of the terms and conditions that guide the trade or business.

Another factor that can help determine the disadvantage of debt financing is the level of bankruptcy. There exists a close relationship between the level of bankruptcy and the level of debt-financing. The higher the amount of loan borrowed from a commercial lender or a family lender, the higher the chances of bankruptcy (Sawyer and Sprinkle, 2009). The equity financing is more advantageous because it allows the governments to assist in cases of bankruptcy. Indeed, some governments through the World Trade organizations and other arms have remarkably participated in establishing, expanding, and rebuilding trade ties between countries that had fallen (Sawyer and Sprinkle, 2009).

Furthermore, debt financing is more risky than equity borrowing because it does not allow the growth of business at a faster rate. This is because the profit from the trade is used in settling the loans that sometimes have high interested rate because of high foreign exchange rate in the market. The graze period that many commercial lenders like the International Monetary Fund (IMF) could be shorter; thus, repaying the loan becomes hard. On the other hand, the equity-financed business has greater chance of expanding because the profit is used in opening constituent centers around the world and improving human capital (Sawyer and Sprinkle, 2009).

Despite the disadvantages, that debt financing has as discussed above, borrowing to finance once business can also be advantageous. First, it allows one to have a full control of one’s business. This allows the business operator to determine the fate of his/her business. He/she is able to make all the decisions that pertains the business like the human resource, profit utility, business expansion and other issues that concern the running of the business. Additionally, debt financing is advantageous because the businessperson does not share the profits with any investor.

Conclusion

Conclusively, the debt financing can be indeed riskier than borrowing in the form of equity. This is because debt financing is limited fulfilling the interests of the commercial lenders, rather than promoting the welfare of the entire partnership. In the 19th chapter of the “international economics” by Sawyer and Sprinkle, they introduce the foreign exchange to address the issue of huge debts. However, the fact remains that borrowing to finance a business is riskier because one also has to have some form of collateral to act as the security measures.

Reference list

Kenen, P. (1964). International Economics. New York: Prentice Hall Publishers.

Sprinkle, R., and Sawyer, W. (2009). International economics. New York: Prentice Hall Publishers.

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1. IvyPanda. "Debt Financing and Equity Borrowing' Comparison." May 28, 2020. https://ivypanda.com/essays/debt-financing-and-equity-borrowing-comparison/.


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IvyPanda. 2020. "Debt Financing and Equity Borrowing' Comparison." May 28, 2020. https://ivypanda.com/essays/debt-financing-and-equity-borrowing-comparison/.

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IvyPanda. (2020) 'Debt Financing and Equity Borrowing' Comparison'. 28 May.

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