The Difference between Equity & Debt

Before reading this Article, First read the Article – Money Users & Providers – The Money Cycle.

This article is all about the relationship between the money users & Money providers by 2 different ways – Equity & Debt.

All of you hear from the Financial advisors repeatedly that, Any Portfolio Must have proper Equity & Debt Allocation. So Why they tell you so? What is basically Equity & Debt is? And what is the relationship between these two?

Well, Any Company can raise the Capital by 2 ways – Equity Finance & Debt Finance.

Debt Finance: -

Well, Debt Finance means a Company or a Government can raise the capital by issuing Debt. In Simple words, Debt Finance means “Borrowing & Lending”. Here the Money users (Company & Government) issues a Debt Certificates (Bonds) and the money providers (Investors like you & me) buy those securities.

By Debt Finance, Governments & Companies raise the desired Capital to fund their various projects and to develop infrastructure & Assets. Here the Company/Government is the Borrower and the Investor is a Lender.

So whenever you buy Government (or Corporate) Bonds, it means that you are the Lender of the Government / Corporate. And The Government is agreed to pay you certain interest.

In case of Debt Relationship, Investor will get fixed amount of return on hi Investment every year.

Equity Finance: -

Well, Equity Finance means a Company can raise the Capital by issuing share certificates. In other words, Equity means the ownership of a Company. Whenever you invest your money in buying Shares (Stocks) of any Company, it means that you are buying that much portion of ownership of that Company.

Here the risk is high and so the return is also high.

Here you are taking the risk of that Business by buying a part of the ownership of that Company. So when the Company will make profits, you will be rewarded more than Debt. So whenever we buy stocks, we are buying an ownership of that Company.

Here is the difference between Equity & Debt -

Equity	Debt
Must be repaid or refinanced	Can usually be kept permanently
Requires regular interest payments. Company must generate cash flow to pay.	No payment requirements. May receive dividends, but only out of retained earnings
Collateral assets must usually be available	No collateral required.
Debt providers are conservative. They cannot share any upside or profits. Therefore, they want to eliminate all possible loss or downside risks	Equity providers are aggressive. They can accept downside risks because they fully share the upside as well
Interest payments are tax deductible	Dividend payments are not tax deductible
Debt has little or no impact on control of the company	Equity requires shared control of the company and may impose restrictions
Debt allows leverage of company profits	Shareholders share the company profits