What is Debt Capital?
Debt Capital is the money that a company raises through borrowing from individuals or institutions, and they must repay the entire amount after a specific time interval. They are a cheaper and low-risk alternative for getting finances when compared to equity capital.
Debt Capital is either secured or unsecured. Secured Debt is a loan that the company takes by pledging its assets. It allows the lender to sell that asset and recover its money if it does not repay within a fixed duration. Unsecured Debt is a borrowing made by the company without pledging any assets as security.
There are three kinds of Debt Capital – Term Loans, Debentures and Bonds. Here is a brief description of the three terms:
- Term Loans – Banks provide Term Loans to companies at a fixed/floating interest rate (according to the loan agreement). These secured loans have a fixed repayment schedule.
- Debentures – Debenture is a debt instrument issued by a company to the general public. They can be secured or unsecured, and the principal amount is repayable after a fixed time interval.
- Bonds – A bond is a fixed income instrument issued by the government or a company to the general public. They have a fixed date of maturity post which the issuer pays back the principal amount to the investor along with interest.
What is Equity Capital?
Equity Capital is the total amount of funds invested by the owners in their business. The equity of a company gets divided into several units, and each unit is called a share. The owners can sell some of these shares to the general public to raise funds. The shares are of two types – Equity shares and Preference shares. Here is a brief description of the two terms:
- Equity Shares – These are ordinary shares of a company that the owners sell in the open market. Investors purchase these shares and become stakeholders in the organisation with ownership rights. They hold voting rights to select the company’s management. They get a percentage of the company’s profits, but only after preference shareholders get their dividend.
- Preference Shares – Preference shares allow shareholders to receive dividends before equity shareholders. They are entitled to a fixed rate of compensation whenever the company declares a dividend. They also have the right to claim repayment of capital if the company dissolves.
Differences between Debt and Equity Capital
The main differences between Debt and Equity Capital are as follows:
| Debt Capital | Equity Capital |
| Definition |
| Debt Capital is the borrowing of funds from individuals and organisations for a fixed tenure. | Equity capital is the funds raised by the company in exchange for ownership rights for the investors. |
| Role |
| Debt Capital is a liability for the company that they have to pay back within a fixed tenure. | Equity Capital is an asset for the company that they show in the books as the entity’s funds. |
| Duration |
| Debt Capital is a short term loan for the organisation. | Equity Capital is a relatively longer-term fund for the company. |
| Status of the Lender |
| A debt financier is a creditor for the organisation. | A shareholder is the owner of the company. |
| Types |
Debt Capital is of three types:- Term Loans
- Debentures
- Bonds
| Equity Capital is of two types:- Equity Shares
- Preference Shares
|
| Risk of the Investor |
| Debt Capital is a low-risk investment | Equity Capital is a high-risk investment |
| Payoff |
| The lender of Debt Capital gets interest income along with the principal amount. | Shareholders get dividends/profits on their shares. |
| Security |
| Debt Capital is either secured (against the surety of an asset) or unsecured. | Equity Capital is unsecured since the shareholders get ownership rights. |
Conclusion
Companies need financing regularly to run their operations successfully. There are several differences between Debt and Equity Capital, but companies need both these instruments to raise funds.
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FAQs
Equity capital is the funds raised by the company in exchange for ownership rights for the investors. Debt Capital is a liability for the company that they have to pay back within a fixed tenure.
What is the difference between debt capital and equity capital? ›
Equity capital is the funds raised by the company in exchange for ownership rights for the investors. Debt Capital is a liability for the company that they have to pay back within a fixed tenure.
What is the difference between equity capital and debt capital Quizlet? ›
Debt financing raises funds by borrowing. Equity financing raises funds from within the firm through investment of retained earnings, sale of stock to investors, or sale of part ownership to venture capitalists.
What is the difference between debt and equity in capital structure? ›
Capital structure is the specific mix of debt and equity that a company uses to finance its operations and growth. Debt consists of borrowed money that must be repaid, often with interest, while equity represents ownership stakes in the company.
How can you tell the difference between debt and equity? ›
Debt financing refers to taking out a conventional loan through a traditional lender like a bank. Equity financing involves securing capital in exchange for a percentage of ownership in the business.
What is the difference between equity and equity capital? ›
Equity represents the total amount of money a business owner or shareholder would receive if they liquidated all their assets and paid off the company's debt. Capital refers only to a company's financial assets that are available to spend.
Which of the following is a difference between debt and equity? ›
Debt financing is when you borrow money, often via a small-business loan, which you repay with interest. Equity financing is when you take money from an investor in exchange for partial ownership of your company. Both options provide cash for your business, but each has pros and cons.
Is debt capital cheaper than equity capital? ›
Combining finance types can help businesses reduce the cost of capital. Because debt funding tends to be cheaper than equity, businesses can blend the two to reduce the overall cost of finance. And it works the other way round too.
Why equity capital is considered riskier than debt capital? ›
Debt is less risky than equity, as the payment of interest is often a fixed amount and compulsory in nature, and it is paid in priority to the payment of dividends, which are in fact discretionary in nature.
What is the difference between debt loans and equity owner's capital? ›
With debt finance you're required to repay the money plus interest over a set period of time, typically in monthly instalments. Equity finance, on the other hand, carries no repayment obligation, so more money can be channelled into growing your business.
The choice between debt and equity funds depends on individual investment goals, risk tolerance, and time horizon. Equity funds offer higher potential returns but come with higher risk, while debt funds are safer but offer lower returns.
What is the difference between debt and equity funds? ›
Debt Vs Equity Fund. Debt funds offer stable returns with lower risk, while equity funds have the potential for higher returns but higher risk. Debt funds generate income through interest, while equity funds generate income through dividends and capital gains.
What is an example of equity capital? ›
Stock is an ownership interest in a corporation. For example, Lisa may form a corporation and issue 5,000 shares of stock and sell some of the shares to her friend for $100 per share. If she sells all 5,000 shares, she will have raised $500,000 in equity capital.
What are the key classification differences between debt and equity? ›
For example, a bond that requires the issuer to make interest payments and redeem the bond for cash is classified as debt. In contrast, equity is any contract that evidences a residual interest in the entity's assets after deducting all of its liabilities.
How do you compare debt to equity? ›
The debt to equity ratio is a measure of a company's financial leverage, and it represents the amount of debt and equity being used to finance a company's assets. It's calculated by dividing a firm's total liabilities by total shareholders' equity.
What is the difference between debt and equity capital markets? ›
The debt and equity markets serve different purposes. First, debt market instruments (like bonds) are loans, while equity market instruments (like stocks) are ownership in a company. Second, in returns, debt instruments pay interest to investors, while equities provide dividends or capital gains.
What is an example of debt capital? ›
Debt capital refers to borrowed funds that must be repaid at a later date, usually with interest. Common types of debt capital are: bank loans. personal loans.
Why is equity capital more expensive than debt? ›
Typically, the cost of equity exceeds the cost of debt. The risk to shareholders is greater than to lenders since payment on a debt is required by law regardless of a company's profit margins. Equity capital may come in the following forms: Common Stock: Companies sell common stock to shareholders to raise cash.
