Difference between Equity and Debt

Key Difference: Debt means a loan, while equity means shareholders and issuing stock.

Debt and equity are two terms that are commonly heard in finance, specifically when it comes to raising capital for a company. These are two of the many ways that are used in order to raise money for a firm, which could be a startup or looking to broaden its horizon.

In simple terms, debt means a loan, while equity means shareholders. Now, if we want to go into further details. In debt financing, money is raised by issuing a loan or a mortgage, which could be on the basis of property or personal. The loan is has a repayment date and has interest. Now, the person issuing the loan will be required to pay the principal amount on the date set and monthly payments on a monthly or yearly basis.

In equity financing, money is raised by including more shareholder or partner to run the firm. Each of these partners help by bringing in their own money and investing it in the firm, thus raising money for the firm. The equity partners will share the profits, as well as sustain the losses. They will also have a say in the firm’s daily activities and how the firm is running.

In addition to financing, debt and equity are also a type of financial opportunity through which a person can invest in a company. In debt investment, a person invests a company by issuing bonds or debentures of the company. It is essentially a loan that is provided to the company. The bond or debenture is a piece of paper that states the amount of investment that is made, the maturity date and the rate of interest. The way this investment works is quite simple. The person gives money to the company, which the company promises to return on a set date. On the maturity date, the company returns the principal amount back to the investor and a little extra. This is considered a minimal risk investment as even if the company is liquidated, the investor is still paid.

Another form of investment is equity, in which the investor usually purchases a company’s stocks or shares, which gives him an ownership stake in the company. The way an equity works is basically the investor pays the owner of the business using cash or cheque, which entitles him to shares or stocks of the company. Basically, the investor purchases these stocks or shares. The higher the number of stocks or shares, the more input the investor gets in how the business is run. The profit is usually the percentage of the required income. For example, if the investor puts in 100,000 of the 1,000,000, the investor would get 10 percent of the profits. However, if the company is liquidated, the investors also suffer as the price of the shares would fall.

Comparison between Debt and Equity:

 

Debt

Equity

Definition

Money is raised by issuing a loan

Money is raised by adding partners

Types of investment

Bond, debentures

Shares, stocks

Risky

Less risky

More risky

Advantages

  • Less volatile
  • Debt allows a fixed sum
  • The owner has full authority of how the firm runs
  • Profits are not divided
  • No monthly/yearly payments
  • No interest
  • Losses are not shared
  • Say in the dividend
  • Say in the price of the stock

Disadvantages

  • Interest on payments
  • Losses incurred are solely shouldered by the owner
  • Major decisions are put to votes
  • Profits are shared among the shareholders

Image Courtesy: rediff.com, houseflippingonline.com

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