Debt Financing vs. Equity Financing: Key Differences

If your business needs money to grow, you generally have two funding options: debt financing and equity financing. As you debate the two, you might consider how much money you need and how quickly. You may also think about what documentation is required for a loan and whether investors will be interested in your business. With this in mind, it’s important to evaluate which business financing option aligns with your goals.

Here’s what to know about debt versus equity financing, including the various options, the advantages of each, and which method might be best for your company at its current lifecycle stage.

What is debt financing?

With debt financing your company borrows money from external lenders like banks, with the agreement that you will repay over time with interest. This financing can come in the form of a traditional bank loan, business line of credit, or credit card.

With debt financing, business owners retain ownership of their company, but take on the responsibility of repayment. Debt financing may be a better method to access capital for established companies with predictable cash flow. Securing debt financing often is quicker than the drawn-out process of wooing investors.

What is equity financing?

Equity financing is when investors fund your company in exchange for an ownership stake in the business. Unlike debt financing you don’t have repayment obligations. Investors receive their money back only if they are able to sell their stake, either on the private or public market. Equity funding may be a good choice for early stage startups seeking significant capital to scale quickly, with the potential of winning significant market share and generating outsized profits.

Debt financing vs. equity financing: How do they compare?

• Qualifications
• Control and ownership
• Advisory resources
• Cash flow and repayment
• Time to receive funding

Debt and equity financing both raise capital for your business, but they work differently—from the criteria to obtain funds to the way funds are ultimately paid back.

These differences include:

Qualifications 

Debt financing can be difficult for early-stage businesses to obtain. Traditional lenders like banks look for assets and revenue—as well as collateral like property or equipment, which could be seized if you fail to repay. Raising equity can also be challenging. It requires identifying potential investors and persuading them to invest based on your vision, experience, and business plan.

Control and ownership

As the common saying goes, equity costs more than debt. Although you aren’t paying interest payments, selling equity requires you to give up a portion of your company. It could even involve a large or majority stake that cedes control of your business operations. 

Advisory resources

Equity investors, particularly those who come in early like venture capitalists and angel investors, can offer valuable expertise and access to their professional networks. Traditional lenders like banks may provide some financial guidance, but they are neither business mentors nor strategic advisers, like investors.

However, the advice and expertise of equity investors can be a double-edged sword. They may disagree with your business decisions or push for exit strategy outcomes, like a sale, that don’t align with your business goals.

Cash flow and repayment

Equity financing involves no immediate financial implications, because you’re selling a part of your company instead of taking on debt.

In debt financing, you will need to repay the money over time—sometimes starting immediately—and this can strain cash flow. With loans and lines of credit, you agree to pay the money back with interest over a fixed term. If you use a business credit card, you’ll incur interest if you make less than the full payment and carry a balance. 

Time to receive funding

Raising equity financing generally takes longer than securing loan approval. You will need to identify investors, pitch them on your business model, undergo due diligence, and negotiate the details of the deal before you receive any capital. Debt financing, like a loan or credit card, is often quicker, especially if you already have a relationship with a bank or lender.

Debt financing options

• Bank loans
• Business line of credit
• Small Business Association (SBA) loans
• Business credit cards
• Invoice factoring

If you’re interested in choosing debt financing, you might consider one or several options in this category:

Bank loans

A bank loan involves borrowing funds from a financial institution, and it can come in several forms. One common type is a term loan, which offers a lump sum upfront and is repaid over a set schedule with a fixed or variable interest rate.

These loans can offer benefits like customizable repayment schedules and a lower cost of debt. However, their rigorous requirements mean typically only established businesses qualify—and some banks may also restrict you from using additional financing options.

Business line of credit

A line of credit (LOC) gives you the option to take out a loan—known as a draw—but it doesn’t require you to take out a loan when you apply. It works like a credit card: You can take out a single loan or a series of loans against your credit limit, and you’ll pay interest only on the amount you borrow. Some types of LOCs require you to put down collateral to secure the loan, and some lenders impose monthly or annual fees.

Small Business Association (SBA) loans

These small business loans are backed by the US Small Business Administration (SBA), which often means lower interest rates and fees than other loans. However, the requirements can be more stringent compared to some other types of startup business loans.

Business credit cards

Credit cards can help your business pay for short- or mid-term expenses while accruing rewards such as airline miles or points. However, they tend to have high interest rates, which kick in if you don’t pay the bill in full each month. They also may limit how much you can borrow.

Invoice factoring

Invoice factoring requires selling your unpaid invoices to a third party. This provides your business with a cash advance in exchange for a fee of about 1% to 5% of the invoice amount.

Equity financing options

If equity financing interests you, there are many paths to use it to support growth:

Angel investors

Angel investors are wealthy individuals who provide startup funding in exchange for ownership stakes. They generally invest between $25,000 and $500,000. However, you’ll need to find a willing angel, make a strong pitch, and accept the dilution of your ownership.

Family and friends

This funding option may come with fewer requirements and more flexibility. However, you will need to ensure the agreement is properly set up for legal and tax implications, and both sides are clear on expectations. If your business encounters unforeseen challenges or ends in complete business failure, these personal relationships may be strained.

Venture capital

Venture capital (VC) is similar to angel investing. It’s a type of financing investors provide to private businesses in exchange for a stake in the company. This usually comes from a venture capital firm composed of multiple investors, whereas angel investors typically are individuals.

Crowdfunding

Crowdfunding involves soliciting funding from members of the public, rather than a large sum of money from one or a few contributors. Some crowdfunding campaigns offer equity to donors as part of the fundraising process, though many only offer products and other rewards.

*Shopify Capital loans must be paid in full within a maximum of 18 months, and two minimum payments apply within the first two six-month periods. The actual duration may be less than 18 months based on sales.