Equity vs Debt Financing: Sources, Product Life Cycle & More
Equity Financing
Equity financing represents the owner’s share of a company’s assets. In a corporation, this is represented by shares of common or preferred stock, depending on the legal form of ownership. Equity financing in a corporation is evidenced by shares of either common or preferred stock.
Role of Equity Financing
Equity financing serves as a buffer, protecting creditors from loss in case of financial difficulty.
Debt Financing
Debt financing comes from lenders who are repaid at a specified interest rate within a specified time span. Small businesses use debt financing for several reasons:
- The cost of interest paid on debt capital is usually lower than the cost of outside equity, and interest payments are tax-deductible expenses.
- An entrepreneur may be able to raise more total capital with debt funding than from equity sources alone.
- Because debt payments are fixed costs, any remaining profit belongs solely to the owners.
One type of debt financing is leasing facilities, which is a contract that permits you to use someone else’s property, such as real estate.
Benefits of Leasing
- Payments are tax-deductible.
- It may be possible to lease equipment when unable to secure debt financing.
Sources of Equity Financing
1. Self-Financing
Owners of small firms often rely on their own capital, which is an important source of financing. They are more dependent on short-term debt than long-term debt and use external financing only occasionally. Owners prefer using their own funds for comfort and to avoid sharing control of the firm.
2. Small Business Investment Companies (SBICs)
SBICs are private firms licensed and regulated by the SBA to make venture investments in small firms. They supply equity capital and unsecured loans to small firms and intend to be profit-making institutions. SBICs prefer to make loans to small firms rather than equity investments and provide management assistance to help in financing.
3. Venture Capitalists
Venture capitalists serve as a form of security blanket when needed. They make investments based on projected future income and generally require a large return as either equity or profit. Venture capital firms have been partnerships composed of wealthy individuals who make equity investments in small firms with opportunities for fast growth, such as Microsoft. A new generation of corporate venture capitalists is jumping in to fill the gap left by the departure of traditional financiers. They are acting as incubators and hands-on advisors.
4. Angel Capitalists
Angel capitalists, or business angels, are wealthy local business people and other investors who may be external sources of equity funding. They provide up to four times as much total investment capital as venture capital.
5. Other Sources
Business incubators help in managing in-house and revolving loan funds, connect with angel investors, and assist with loan applications. Employee stock ownership plans allow businesses to gain tax advantages and cash flow advantages by selling stock shares to workers.
Sources of Debt Financing
1. Trade Credit
Trade credit is extended by vendors on the purchase of inventory, equipment, and supplies. With consignment selling, payments to suppliers are made only when the products are sold rather than when they are received in stock.
2. Commercial and Other Financial Institutions
These provide small business owners with borrowed funds, which may be more expensive than other alternatives but may be the most accessible. Commercial banks are the dominant supplier of external financing to small firms. A line of credit permits a business to borrow up to a set amount without red tape. Credit cards are another form of credit line. Insurance companies are a good source for small firms, especially real estate ventures.
Product Life Cycle
The product life cycle consists of four stages: Introduction, growth, maturity, and decline.
1. Introduction Stage
This stage begins when a product first appears on the market. Prices are high, and sales are low. Profits are negative because of high development costs.
2. Growth Stage
Sales rise rapidly, and profits peak. As competitors enter the market, they attempt to develop the best product design. In this stage, marketing strategy encourages brand loyalty.
3. Maturity Stage
Competition becomes more aggressive, leading to declining prices and profits. Competitors cut prices to attract businesses; new firms enter and increase competition.
4. Decline Stage
Sales fall rapidly, especially if a new technology is involved.
Merchandising
Merchandising involves promoting the sale of a product at the point of purchase. For example, when you go to a store and see someone with a microphone constantly talking about a product to attract customers to buy it.
Attributes of a Creative Salesperson
Mental Attributes
Judgment is essential for effective selling. For example, good salespeople do not argue with customers or criticize the business in front of customers.
Physical Attributes
Personal appearance is important for success. For example, a slim salesperson would be more appropriate than a larger person for a health spa.
Prospecting
Prospecting consists of taking the initiative in dealing with new and regular customers by going to them with a new product idea. For example, when a salesperson calls a bride-to-be and tells her about goods that are appropriate.
Recruitment
Recruitment is reaching out to attract a supply of potential employees. It is done by:
- Advertising
- Networking: The process of establishing and maintaining contacts with another organization as informal development or promotion systems.
- Employment agencies
- Scouting, such as campus recruiting.
- Employee referral, such as recommendations from present employees.
- Temporary help services, such as agencies providing part-time employees.
- Internet or website.
Selection
Selection involves choosing the applicant who has the qualifications to perform the job. The selection procedure involves:
- Gathering information about the applicant.
- Using employee input.
- Preliminary screening through formal interviews or reviewing candidate application forms.
- Gathering biographical information, such as school records and resumes.
- Giving pre-employment tests, which must be job-related.
- Interviewing applicants in depth or conducting diagnostic interviews to determine the applicant’s character and other aspects of personality.
- Checking references (personal, academic, and past employment).
- Giving physical examinations.
- Making a job offer, including details of working conditions.
- Orienting the new employee, including introductions to co-workers and some explanation about business procedures, policies, and benefits.
The Balance Sheet
The balance sheet is prepared to show the assets, liabilities, and owner’s equity of the business at a given time. The balance sheet can be used as a gauge of the financial health of your company.
What is Profit Planning?
Profit planning is a series of steps to be taken to ensure that a profit will be made. To make a profit, your prices must cover all direct and indirect costs and include a markup for planned profit.
What is the Financial Structure of a Business?
It is the assets, liabilities, and equity accounts of a business, which are interrelated and interact with each other.
Income Statement
An income statement is a financial statement that reports a company’s financial performance over a specific accounting period. Financial performance is assessed by giving a summary of how the business incurs its revenues and expenses through both operating and non-operating activities.