Differences Between Debt and Equity

Debt and equity are the external sources of finance for a businessExternal Sources Of Finance For A BusinessAn external source of finance is the one where the finance comes from outside the organization and is generally bifurcated into different categories where first is long-term, being shares, debentures, grants, bank loans; second is short term, being leasing, hire purchase; and the short-term, including bank overdraft, debt factoring.read more. When a company needs a lot of money to expand projects or reinvestment and improve their products, services, or deliverables, they go for equity and debt.

  • Equity is helpful for those who would like to go public and sell the company’s shares to individuals. To conduct an IPO, a company needs to bear various costs; but the result is most cases are helpful.In the case of debt, the story is slightly different. Businesses opt for debt for two main reasons. Firstly, if the company has gone through the route of equity, then they would take a portion of the debt to create leverage. Secondly, many businesses don’t want to go through the complicated process of IPO, so they opt for a route to take debt from the banks or financial institutions.

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Debt vs Equity Infographics

Let us see the top differences between debt and equity.

Key Differences

  • Debt is a cheap financing source since it saves on taxes. Equity is a convenient funding method for businesses that do not have collateral.Debt holders receive a predetermined interest rate along with the principal amount. Equity shareholders receive a dividend on the company’s profits, but it is not mandatory.Debt holders are not given any ownership of the company. However, equity shareholders are given the right of the company.Irrespective of profit or loss, the company must pay debt holders. However, equity shareholders only receive dividends when the company generates profits.Debt holders do not have any voting rights. However, equity shareholders have voting rights to make significant business decisions.

Comparative Table

Conclusion

We have seen the major differences between debt and equity; both are important for a business. Thus, talking about which is more valid is redundant.

We should rather talk about in which proportion a business can use them. Depending on the industry and the capital intensivenessCapital IntensivenessCapital intensive refers to those industries or companies that require significant upfront capital investments in machinery, plant & equipment to produce goods or services in high volumes and maintain higher levels of profit margins and return on investments. Examples include oil & gas, automobiles, real estate, metals & mining.read more of that industry, the company needs to decide how many new shares they will issue for equity financing and how much secured or unsecured loan they would borrow from the bank. Of course, striking a balance between debt and equity is not always possible. But the business should ensure they can take advantage of the leverage and, simultaneously, not pay too much in the cost of capital.

Debt vs Equity Video

This article is a guide to Debt vs Equity. Here, we discuss the top differences between debt and equity, infographics, and a comparison table. You may also have a look at the following articles to learn more: –

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