Define Debt and Equity Financing and Discuss How They Differ

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Examlex · Accepted Answer

The Answer is Debt is a financial obligation to return the capital provided plus a scheduled amount of interest. Equity is a portion of ownership received in an organization in return for money provided.
There are two reasons why new ventures tend to be financed by equity. First,until ventures have generated positive cash flow,they have no way to make scheduled interest payments. Second,debt financing at a fixed rate of interest encourages people to take risky actions when investors can't observe entrepreneurs' decisions. As a result,entrepreneurs need to raise money in a way that doesn't require them to make fixed payments,so they tend to lean towards equity financing. With equity investments,the entrepreneur would have to share any greater benefit that accrues from success at risky actions and so won't be as inclined to take them. Occasionally new ventures do obtain debt financing. It is usually debt guaranteed by the entrepreneur's personal assets,asset-based financing which is secured by the equipment that it is used to buy,or supplier credit.

Define Debt and Equity Financing and Discuss How They Differ

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