The word “finance” means different things to different people both individuals and businesses/companies. It can refer to the money someone has in their bank account, or it can refer to a financial institution that offers loans and other services to customers. There are basically two types of financing you can find
- Debt
- Equity
In this article, we will discuss both types of financing in more detail. So if you are interested in learning how Debt and Equity works, keep reading!
What is Financing
Before we start learning about different types of financing, it is important to understand what financing actually means. A simple definition of financing is using money to pay for something like a house, car, business, etc. A more detailed explanation is that it is the use of capital (money) – usually borrowed or accumulated over time by an individual or company – to make purchases and investments which will generate income in the future. There are two major sources of financing you can find
-
Debt Financing
Debt financing is an agreement to use the money for a certain period, with the promise to pay back that amount of money plus interest in the future. Debt financing could be either short-term or long-term.
A short-term debt refers to borrowing money only until it’s needed for something like daily business activities. On the other hand, long-term debt refers to borrowing money for an extended time like buying a house or car that would last you more than one year. There are basically two types of debt financing: Loan and Credit.
-
Equity Financing
Equity financing is the selling of part ownership in a business for money needed to start or grow the business. When a company sells equity, it is giving up a portion of the ownership in return for cash from the new shareholder. The most common way to get equity financing is by issuing shares of stock to investors.
How Debt Financing Works
There are two types of debt financing
-
Loan
When a company or individual takes out a loan, it is borrowing money from a financial institution and agreeing to pay back that money plus interest. The loan could be for a short-term or long-term.
-
Credit
Credit is the borrowing of money from a creditor or vendor with a promise to pay back that money later. Most people are familiar with credit cards or store credit accounts which allow them to buy things now and pay for them in the future. The amount of payment will vary based on the arrangement made between creditors and borrowers.
Process of Debt Financing
The process of debt financing is pretty straightforward. The company or individual looking for money approaches a financial institution, such as a bank, and asks for a loan. The financial institution will then look at the credit history of the company or individual and decide if it is willing to lend them the money. If it is, the financial institution will usually require the company or individual to sign a contract agreeing to pay back the money plus interest.
How Equity Financing Works
Equity financing is a little different than debt financing in that the company or individual is selling part ownership in their business for cash. When a company sells equity, it is giving up a portion of the ownership in return for cash from the new shareholder. The most common way to get equity financing is by issuing shares of stock to investors.
Process of Equity Financing
The process of equity financing is slightly different from debt financing. First, the company or individual must create a shareholder’s agreement that sets up the rights and responsibilities for shareholders. Then, they will need to find investors interested in buying equity and pitch them on their business idea and how it could be profitable for them if they invest. If the investors agree, the company or individual will give them some shares of stock and then begin trading on a public stock exchange.
Best Strategies for Debt Financing
Here are some of the best strategies to gain debt financing for your business
- Have a good credit history
- Provide collateral
- A business plan that demonstrates how the money will be used efficiently
- Good financial statements
Best Strategies for Equity Financing
Here are some of the best strategies to gain equity financing for your business
- Find investors who are venture capitalists or angel investors
- Build a good reputation in your industry by attending networking events, speaking at conferences, etc.
- Create a high-quality website with excellent content
- Have a good social media presence
- Have press releases on credible sites like Forbes or Entrepreneur
Conclusion
In conclusion, there are two types of debt financing: loans and credit. Each of them has its own process. Debt financing is when a company or individual takes out a loan and agrees to pay back that money plus interest. Equity financing is when a company sells part ownership in their business for cash. Each of them is used for different reasons and what you are trying to accomplish.
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