Debt vs Equity
Debt and equity are two primary sources of funding for businesses. Debt involves borrowing money that must be repaid with interest, while equity involves selling ownership stakes in the company. Debt provides immediate funds but comes with the obligation of repayment, while equity offers long-term investment but dilutes ownership and may involve sharing profits.
7 Key excerpts on "Debt vs Equity"
eBook - ePub- Robert McCallion, Alan Warner(Authors)
- 2010(Publication Date)
- Teach Yourself(Publisher)
...6 Sources of funding In this chapter: the main sources of funding: debt and equity sources of equity funding loan capital types of loan agreement requirements for loan finance real-life stories The main sources of funding: debt and equity There are two main alternative sources of funding but, within that framework, a number of options. The alternatives are the choice between two fundamentally different forms of finance – debt and equity – which we need to explain before we look at the options in more detail. Debt finance is money borrowed from people or institutions that are willing to lend you money, on which you will have to pay interest. The bad news is that this interest has to be paid whether or not you make profit; the good news is that the lenders are not in any way owners of the company and will not be entitled to voting rights or dividend. Equity finance is money obtained from investors to whom you are, in return, giving a share of the ownership. The implications are the reverse of the above; the bad news is that you have to share dividend with them when profits are made; the good news is that they cannot insist on such payment if profits are not being made. Insight It is interesting – and a frequent source of confusion – that the risk of taking equity finance, rather than debt, can be seen in opposite ways, depending on your perspective. Equity is higher risk for the investor but lower risk for the company. This fundamental difference should be the basis of the choices you make once you know how much cash is required to run the business and, in principle, it should be determined by your attitude to risk...
eBook - ePubIntroduction to Business
A Primer On Basic Business Operations
- Patrice Flynn(Author)
- 2019(Publication Date)
- Business Expert Press(Publisher)
...CHAPTER 8 Equity Finance All business owners need money—known as financing—to establish a firm, to operate daily, and to grow in whatever ways the owner deems best. Two of the most common forms of financing are equity and debt. The value of equity financing is that the money people invest in your business does not come with a promise that it be repaid. Debt financing, in contrast, requires repayment with some type of compensating interest, as negotiated. This chapter provides examples of equity financing, followed by examples of debt financing in the next chapter. What Is a Business? An organization comprised of people who produce goods and services to sell to earn a profit distributed to stakeholders Equity finance is a form of financing in which you convince other people to invest money directly into your business. This money could be used for myriad purposes, ranging from building a new office, developing a new product, paying off debt, purchasing equipment, hiring workers, buying inventory, to paying off accounts receivable. Securing equity finance requires aggressive fundraising on your part as the owner or the responsible party representing someone else’s business. Anyone with money to invest is a possible source of equity financing, such as other business owners interested in your firm, individual investors, or the owners of the business itself. Anyone with money to invest is a possible source of equity financing, such as other business owners interested in your firm, individual investors, or the owners of the business itself. Equity investors own a part of your business and expect to be financially rewarded if the business is a financial success. Let’s look at five types of equity finance common to business: owner’s equity, shareholder’s equity, retained earnings, venture capital, and assets. Type 1: Owner’s Equity Owner’s equity is a straightforward, quick, and simple way to raise money for a business...
eBook - ePubAccounting and Finance for Managers
A Business Decision Making Approach
- Matt Bamber, Simon Parry(Authors)
- 2020(Publication Date)
- Kogan Page(Publisher)
...The two main types of finance are equity finance and debt finance (Figure 10.1). There are a variety of sources of each of these two types of finance and we will explore these below. Figure 10.1 Classification of finance Equity finance is usually open-ended and therefore long term. That is to say, there is no redemption date. Rather, shares will stay in existence for as long as the business. However, debt finance normally has a fixed term with a predetermined repayment date or dates. Debt finance is therefore often classified into three broad categories of term: short term, medium term and long term. short term = less than one year medium term = 1 to 5 years long term = longer than five years Equity finance Equity finance is often referred to as risk capital. This is because it usually attracts the highest levels of risk for investors and at the same time promises the highest return. The return on shares (dividends) is paid after all other debtors have been paid and only if sufficient funds remain. In the event of insolvency shareholders will rank after all other creditors. There are a number of different types of equity finance, and the variety available reflects the need to provide a wide range of risk levels for different investors and a range of different financing options to meet different business situations. Although many companies will have only one class of shares (ordinary shares), it is possible and increasingly common for even small private companies to have different share classes that confer differing levels of rights and rewards. Ordinary shares Ordinary shares are the default class of share and confer ownership rights. That is to say, holders of ordinary shares are regarded as the owners of the business. Ordinary shares will carry voting rights (one vote per share) and are entitled to participate equally in dividends when the company has the financial resources to pay them...
eBook - ePub- Debi J Peverill(Author)
- 2018(Publication Date)
- Painless Financial Training Group Inc.(Publisher)
...Creditors do not normally become owners of the business. Equity financing is provided by investors who buy shares in your company. When they sell the shares, these investors receive the investment back. Equity investors can receive dividends and have the possibility of capital gains if they are able to sell their shares for more than they paid for them. We are going to start this chapter’s discussion with debt. Types of Debt Financing There are a number of basic types of debt financing. • Mortgages • Bank term loans • Bank line of credit • Accounts payable • Leasing • Related party borrowing Mortgages A mortgage is a loan that is used to finance capital assets. It is provided by banks and institutional lenders, typically for a term of between fifteen and twenty-five years. A mortgage is always secured by an asset of some description, most commonly a house or a building. Many individuals own a home that is being financed by a mortgage. Payments are made regularly, typically monthly or bimonthly. At some point, the mortgage is paid off and the individual owns the house free and clear. Most people plan to pay off their mortgage and have 100 percent equity in their home. The acquisition of a building in a business is a classic example of creating equity in an asset. A business buys a building and pays for it over a long period of time. This is a great use of debt because you are paying for something that is increasing in value. A mortgage is not a difficult loan to get from a bank, primarily because the security is so good. A building is always where you left it. Land and buildings do not generally decrease in value although it has happened in certain markets. Chapter 13 talks about the criteria that bankers use to determine whether they are going to lend anyone money. When you read that chapter, remember this discussion...
eBook - ePubAngel Financing for Entrepreneurs
Early-Stage Funding for Long-Term Success
- Susan L. Preston(Author)
- 2011(Publication Date)
- Jossey-Bass(Publisher)
...Also, redemption rights or the right to force the company to repurchase shares as a term of a stock offering (almost always preferred stock) would be considered a legal obligation for repayment. Nonetheless, investors approach a stock investment differently from a debt, both psychologically and in terms of benefit expectations. Because of the greater risk of loss, investors often take longer to make an equity investment decision and often require more information in the due diligence process. In addition, because of the higher level of risk, investors expect to receive a greater potential benefit. Preferred stock provides additional rights, preferences, and privileges to create at least a perceived balance for the investor between benefit and loss. Based on this reasoning, equity investments are best for high-growth potential ventures, since debt instruments (unless convertible) have a predefined cap on gain through interest payments (and perhaps some additional stock in the form of a warrant). In contrast, equity investments can achieve major multiples, sometimes returning ten or twenty times the investment—or more, on huge successes. You’ve surely seen the occasional news clip about angels and other early-stage investors putting in $100,000 that is now worth $10,000,000, which is why many angels get in the business in the first place. From your perspective as the entrepreneur, equity investing has a lower financial risk since it generally does not carry an obligation of cash payments (except perhaps for mandatory dividend payments), whereas debt servicing will entail interest and principal payments. Also, some debt financing methods, such as lines of credit, have restrictive covenants that could cause you to default...
eBook - ePubWriting a Business Plan
A Practical Guide
- Ignatius Ekanem(Author)
- 2017(Publication Date)
- Routledge(Publisher)
...bank loans) and equity providers (e.g. shareholders). A higher debt to equity ratio indicates that more debt financing is used than equity financing. A debt to equity ratio of 1:1 means that investors or shareholders and loan providers have an equal stake in the business. A lower debt to equity ratio is usually preferable as it implies a more financially stable business. A higher debt to equity ratio is often considered to be highly geared and therefore more risky to creditors and investors than a lower ratio as debt must be repaid to the lender with interest. Formula The debt to equity ratio is calculated by dividing total debts by total equity. It is considered a balance sheet ratio because all of the elements (debt and equity) are reported on the balance sheet. Debt/equity ratio = Debt/Equity (usually expressed as a ratio 1:1 or 2:1; the ideal is 1:1) Example Since B. Smart Ltd has equity of £100,000, but no long-term debt, the company has no gearing and therefore is not risky at all. However, suppose the company had a long-term debt of £200,000 from the bank; the debt to equity ratio would be as follows: Debt/equity ratio = £ 200, 000 £ 100, 000 = 2 This means that the gearing position is 2:1, which is highly geared, and investors and creditors would certainly view this company as risky. It suggests that investors have not funded the business as much as creditors. It also suggests that investors are unwilling to fund the business because it is not performing well. However, in rare cases, bank managers and other funders may still provide funding to a company with a 2:1 gearing position, provided the company exhibits other favourable characteristics such as a strong management team, a good track record and experience. (b) Interest cover This ratio measures a company’s ability to make interest payments on its debt in time. In other words, it shows the number of times interest payments are covered by a company’s profit before interests and tax...
eBook - ePubCorporate Valuation for Portfolio Investment
Analyzing Assets, Earnings, Cash Flow, Stock Price, Governance, and Special Situations
- Robert A. G. Monks, Alexandra Reed Lajoux(Authors)
- 2010(Publication Date)
- Bloomberg Press(Publisher)
...APPENDIX A Equity vs. Debt Securities A Global Definition FROM 2007 to mid-2010, a joint task force of the International Accounting Standards Board (IASB) and the Financial Accounting Standards Board (FASB) labored to build the basis for global definition of equity. During their deliberations on the Financial Instruments with the Characteristics of Equity in April 2007 and for the following year, the task force proposed that “the distinction between equity (risk capital) and liabilities is based exclusively on the ability or inability of capital to absorb losses incurred by the entity, with losses being tentatively understood as accounting losses.” 1 However, at the joint board meeting in October 2007, the IASB used a new definition called the perpetual approach (that is, no settlement feature and entitlement to pro-rata share on liquidation of the issuing entity) and the basic ownership approach (that is, most subordinated instrument and entitlement to percentage of net assets). On December 11, 2008, the boards decided that all instruments that have no contractual settlement requirement (perpetual instruments) and that entitle the holder to a share of the issuer’s net assets in liquidation should be classified as equity...
