Indirect financing occurs when a company borrows money from a financial intermediary, such as a bank, according to Oswego University. The company pays the intermediary interest while the intermediary pays interest to its investors or depositors. Direct financing involves the company’s borrowing of funds directly from investors.
According to Oswego University, indirect financing is more important than direct financing methods. This is due primarily to the added efficiency available through the financial intermediary. With indirect financing, the intermediary takes care of gathering together multiple investors, reduces investor risk by performing due diligence on the borrowers and provides a larger pool of funds from which the borrower can pull quickly.
Direct financing, according to Oswego University, requires that the borrower go directly to investors, which lengthens the time needed to raise the desired funds. The methods used for direct financing include offering shares of the company for sale to investors or floating bonds. When shares are sold, instead of paying interest a company may provide dividend payments. Bonds still require the payment of interest to the bondholders, using either a set interest rate that remains constant or a variable rate that changes according to the particular rate index to which the variable rate is pegged.
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