When should a company consider issuing debt instead of equity?

Debt is cheaper because it is paid before equity and has collateral backing. Debt ranks ahead of equity on liquidation of the business when comparing the cost of debt to the cost of capital

There are pros and cons to financing with debt vs equity that business needs to consider. It is not automatically a better to use debt financing simply because it's cheaper. A good answer to the question may highlight the tradeoffs, if there is any followup required.

Businesses often need external money to maintain their operations and invest in future growth. There are two types of capital that can be raised: debt and equity. Each type has its share of benefits and drawbacks.

Debt financing is capital acquired through the borrowing of funds to be repaid at a later date. Common types of debt are loans and credit. In addition, payments on debt are generally tax-deductible. The downside of debt financing is that lenders require the payment of interest, meaning the total amount repaid exceeds the initial sum. Also, payments on debt must be made regardless of business revenue (during economic slowdowns, slow down in sales, or new companies) this can be dangerous.

Equity financing refers to funds generated by the sale of stock. The main benefit of equity financing is that funds need not be repaid. Shareholders purchase stock with the understanding that they then own a small stake in the business. The business is then beholden to shareholders and must generate consistent profits in order to maintain a healthy stock valuation and pay dividends. Since equity financing is a greater risk to the investor than debt financing is to the lender, the cost of equity is often higher risk than the cost of debt.

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