what is debt and equity

Debt and equity are two fundamental ways companies raise capital, each with distinct characteristics and implications for businesses and investors.

Debt

Debt refers to borrowed funds that a company must repay over time, typically with interest. It includes loans, bonds, and other credit instruments. Key features:

Obligation to Repay: The company must repay the principal plus interest, regardless of profitability.

Fixed Cost: Interest payments are usually fixed, making debt predictable but burdensome if cash flow is weak.

No Ownership Dilution: Lenders (creditors) do not gain ownership rights in the company.

Tax Benefits: Interest payments are often tax-deductible, reducing taxable income.

Priority in Liquidation: In bankruptcy, debt holders are paid before equity holders.

Equity

Equity represents ownership in a company, obtained by issuing shares. Investors (shareholders) gain a stake in the business. Key features:

No Repayment Obligation: Unlike debt, equity does not require repayment, reducing financial pressure.

Profit Sharing: Shareholders earn returns through dividends and capital appreciation.

Ownership & Voting Rights: Equity holders may influence company decisions via voting rights.

Higher Risk & Reward: If the company thrives, shareholders benefit more; if it fails, they lose their investment.

Last in Liquidation: In bankruptcy, equity holders are paid after creditors.

Comparison

Risk: Debt is safer for investors but riskier for companies (due to repayment pressure). Equity is riskier for investors but safer for companies (no repayment obligation).

Cost: Debt is cheaper (tax benefits), but equity avoids financial distress.

Control: Debt does not dilute control, while equity may.

Both financing methods have trade-offs, and companies often use a mix (capital structure) to optimize growth and stability.