Debt Finance Versus Equity Finance

Let us today understand in Layman’s language that, What it means by Debt Finance and Equity Finance? Understanding both of these terms in very easy language will help you to raise Capital for your Business.

Well, In simple language, Both of these options are used to raise Capital for your Business. A Business needs capital for many reason. Commonest reason is to fuel its growth and expansion. A Business needs a constant capital for its growth and expansion. And Business owners (Promoters of the Company) raise money for their future projects via any one or both of the above options.

What is Debt Finance? -

Well, a Debt Finance means – A Business borrows Money for its growth and expansion (Or for any other reason which is in benefit of Business). One of the oldest way to raise money for Business expansion is to borrow money (Debt Finance). A Business can borrow money from either Banks or Financial Institutions or may from the public by issuing Bonds (Say for Example, TATA Motors Bonds are the classic example of Debt Finance. Here TATA Motors has raised money from Public.). Whenever you buy a Bond of some Company, it means that you have lend your money to that company and that company is your borrower and it has to pay you your money back as well as interest on it.

What is Equity Finance? -

Well, Equity Finance means – A Business raises money by partially selling its ownership (Shares). When the Business owners (Promoters) don’t want to go for Debt Finance, they can partially Sell their Business and raise money. For doing so, the Business has to go public and make its securities (Stocks) made publically listed on the stock exchanges.

You are buying the stocks of Reliance, ICICI, Google, Microsoft, BHEL…etc… what are they? Well, they are the ownership of the businesses trading on the stock exchanges. There are certain advantages and disadvantages of Equity Finance. The advantage is that, if you partially sell your Business ownership (Shares) than you don’t need to borrow money from anyone and thus no worry about default. Because even if the raised capital will be lost, you don’t have to repay it to its owners.

At the same time, the disadvantage is that, if you partially sell your Business, it will dilute or reduce your own stake (Equity/Ownership) in your Business.

Thus, both of these options are to raise money for your business. you should exercise any of these options carefully according to your business needs.