We know the company must need capital to widen market or raise the operation in order to get profit. The company could raise capital from debt or equity. They can get capital from debt, equity or both of them. The debt or equity has the strength and weakness. Therefore you must consider it before you choose whether the debt or the equity.

The pros using debt:

1. The debt deducts your tax. Since you must pay the interest and principal, you will get the tax deduction
2. The interest rate today is lower because the sub prime crisis. Today the Fed rate is around 2%. Therefore, you must offer the interest higher than 2 %.
3. By using debt, you are free to operate your company by yourself. The bondholder does not have voting right so they cannot decide the corporate operation.

Meanwhile, the cons of using debt are:

1. You must pay interest and principal monthly. When the interest is higher, you must pay more. You could default when you cannot settle the debt.
2. The creditor will ask your asset as a guarantee. They have right to seize your asset when you fail to pay the debt.
3. Your company will bankrupt if your company could not pay the debt. The administration may close your company.

You should consider the equity too because the equity has some strength like:

1. The administrator could reduce tax when company issues shares. In my country, the SEC gives the tax incentive to the company who issues the equity at the exchange.
2. We do not have to pay interest monthly. We should pay dividend only when we get profit. When our business needs money, we can keep some profit to widen the market.

The weaknesses of equity are:

1. Other investment could decide your company. If the investor hold more stock, they have right to operate the company. Since the stock has voting right, so they can determine the corporate policy. Perhaps the stockholder could disturb your leadership. When you decide to widen market, the stockholder could refuse it.
2. The stock price could drop in market exchange and could drop your equity too.

You are free to choose your financing whether debt or equity. They will give you the profit when you know use it. You must calculation the profit from capital.

Some company combines both equity and debt to get the maximal profit. Modigliani and Miller (MM) the winners of Noble prizes- theory have show that the combine debt and equity has same return with equity financing.

Learn more about this author, aforlan.
Click here to send author comments or questions.

---

Add your voice

Know something about Debt vs. equity financing?
We want to hear your view. Write now!