Deciding Between Debt or Equity Securities Financing

What you need to know about each type of offering

By Super Lawyers staff | Reviewed by Canaan Suitt, J.D. | Last updated on March 28, 2024 Featuring practical insights from contributing attorney Mary Ann Frantz

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In order to build and expand a business with sustainable cash flows, you may need access to outside capital. Your options for raising money from investors can be broken down into two broad categories: debt financing and equity financing. So, what are the differences, and how do you decide between the two?

“There’s a real continuum between debt and equity with a lot of hybrid instruments in between that have characteristics of both,” says Mary Ann Frantz, a corporate finance attorney at Miller Nash in Portland, Oregon.

“It really comes down to the financial strength of the organization, what purpose they’re raising the capital for, what their prospects appear to be, and whether they’re a more stable business where they’re not likely to increase rapidly in value, unlike a startup company. There are many different factors to consider.”

Four Benefits of Debt Financing

Simply put, debt financing occurs when a company sells “debt instruments” to outside investors. “With equity, you don’t have to pay it back, while with debt, you theoretically do,” Frantz says. In effect, debt financing is a loan. The money raised from investors must be paid back in accordance with the specific terms of the debt instrument.

Depending on the circumstances, debt financing may be the best option for a business looking to raise capital. Here are four advantages of debt financing:

  1. Debt financing does not dilute one’s ownership stake or decision-making power in the business;
  2. Debt financing allows for significant real returns if the company can use the funds that were raised to promote strong growth;
  3. The repayment terms and conditions are generally fully known at the time of the transaction—meaning debt financing allows for predictability;
  4. The interest payments on the debt are usually tax deductible for a business.

If you’re doing anything other than a very small, standard transaction, you should always get legal advice.

Mary Ann Frantz

Three Advantages of Equity Securities Financing

Equity securities financing is an alternative to debt financing. Instead of taking out a loan from investors, the company sells some of its shares in exchange for an influx of investor capital.

“People who are looking for a major pop in appreciation and value are going to head more towards equity, while debt has more certainty of repayment,” Frantz explains. “It’s never absolutely certain, of course, but there’s usually either a fixed return or a variable interest rate. But in any event, there is a return that’s penciled into the debt document.”

Here are three key advantages of equity securities financing:

  1. Equity financing does not have to be repaid—meaning it allows business owners to reduce their risk;
  2. Equity financing, at least initially, decreases a company’s “debt-to-equity ratio”—meaning the company remains in a better position for loan approval and issuance by lenders if necessary;
  3. There is no reason to worry about monthly fixed costs related to the investment because there is no repayment and interest rate, unlike debt financing.

Should I Get a Corporate Finance Attorney?

Business financing can be complicated. Not only do you need to decide on the right approach, but it is crucial that you execute the transaction properly. Notably, if your business is offering debt or equity securities, there are important federal and state laws as well as regulatory bodies that apply, potentially including the Securities Act of 1933 and the Securities Exchange Act of 1934.

“If you’re doing anything other than a very small, standard transaction, you should always get legal advice,” Frantz says.

“Even a large, sophisticated company that has standard forms of contract still sends us all of their loan contracts to confirm that they are being filled out correctly. If it’s a significant transaction to the borrowers or the company that’s offering securities, you should always get legal advice because, similar to real estate agents, the business broker or investment banker, while technically representing the company issuing securities, has a significant interest but their main interest in earning a commission that is dependent on closing the transaction.”

There are no one-size-fits-all solutions to financing a startup company or other type of small business. Professional guidance is available when deciding between equity investments and debt securities. A corporate finance lawyer will help you determine the best course of action for your business, including regulatory compliance in investment decisions. If you have any questions about debt offerings and equity offerings, an experienced securities attorney can help.

For general information on types of securities and the regulatory role of the U.S. Securities and Exchange Commission (SEC), see our overview of securities law.

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