What is the difference between debt and equity repayment?
"Debt" involves borrowing money to be repaid, plus interest, while "equity" involves raising money by selling interests in the company. Essentially you will have to decide whether you want to pay back a loan or give shareholders stock in your company.
Since Debt is almost always cheaper than Equity, Debt is almost always the answer. Debt is cheaper than Equity because interest paid on Debt is tax-deductible, and lenders' expected returns are lower than those of equity investors (shareholders). The risk and potential returns of Debt are both lower.
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 main advantage of debt finance is the fact that you retain control of the business and don't lose any equity in the company. This means that you won't need to worry about being sidelined or having decisions taken out of your hands. Another key benefit is the fact that it's time-limited.
| Points | Debt | Equity |
|---|---|---|
| Ownership | No ownership dilution | Ownership dilution |
| Repayment | Fixed periodic repayments | No obligation to repay |
| Risk | Lender bears lower risk | Investors bear higher risk |
| Control | Borrower retains control | Shareholders have voting rights |
Debt-to-equity (D/E) ratio is used to evaluate a company's financial leverage and is calculated by dividing a company's total liabilities by its shareholder equity.
Generally, debt funds are considered safer than equity funds because they primarily invest in fixed-income securities with lower volatility. However, the level of safety depends on the credit quality and maturity of the underlying securities.
Equity should be used for financing when the risk of not being able to service debt (payment of principal and interest) is high. If you can't repay, don't borrow!
Debt can be in the form of term loans, debentures, and bonds. Equity can be in the form of shares and stock. Return on debt is known as interest, a charge against profit.
What happens when debt is more than equity?
A high debt-to-equity ratio comes with high risk. If the ratio is high, it means that the company is lending capital from others to finance its growth. As a result, lenders and Investors often lean towards the company which has a lower debt-to-equity ratio.
The debt-to-equity (D/E) ratio reflects a company's debt status. A high D/E ratio is considered risky for lenders and investors because it suggests that the company is financing a significant amount of its potential growth through borrowing.
The main disadvantage of debt financing is that interest must be paid to lenders, which means that the amount paid will exceed the amount borrowed.
- Qualification requirements. You need a good enough credit rating to receive financing.
- Discipline. You'll need to have the financial discipline to make repayments on time. ...
- Collateral. By agreeing to provide collateral to the lender, you could put some business assets at potential risk.
When you take out a loan, you don't have to pay income taxes on the proceeds. The IRS does not consider borrowed money to be income. If the creditor cancels the loan, with some exceptions the amount of the forgiveness usually does become income. Then the forgiven debt is subject to taxation at your regular tax rate.
An optimal capital structure is the best mix of debt and equity financing that maximizes a company's market value while minimizing its cost of capital. Minimizing the weighted average cost of capital (WACC) is one way to optimize for the lowest cost mix of financing.
The level of risk and return associated with debt and equity financing varies. Debt financing is generally considered to be less risky than equity financing because lenders have a legal right to be repaid.
The formula for calculating the debt-to-equity ratio is to take a company's total liabilities and divide them by its total shareholders' equity. A good debt-to-equity ratio is generally below 2.0 for most companies and industries.
The debt-to-equity ratio is primarily used to evaluate a company's ability to raise cash from new debt. That assessment is made by comparing the ratio to other companies in the same industry. The higher a company's debt-to-equity ratio, the more it is said to be leveraged.
High-interest loans -- which could include payday loans or unsecured personal loans -- can be considered bad debt, as the high interest payments can be difficult for the borrower to pay back, often putting them in a worse financial situation.
What is blue chip fund?
What is a Blue Chip Fund? A blue chip fund invests in stocks / shares of well-established companies with credible track records of financial performance that includes among other criteria - a steady payout of dividends and profitability over the years.
Otherwise known as bootstrapping, self-funding lets you leverage your own financial resources to support your business. Self-funding can come in the form of turning to family and friends for capital, using your savings accounts, or even tapping into your 401(k).
Key takeaways:
Equity financing is essential to new companies just starting out. But once you have some equity as a startup, leveraging debt financing makes sense. Use both debt and equity together to create an optimal capital structure and make your company more financially stable as you grow.
Your home is on the line. The stakes are higher when you use your home as collateral for a loan. Unlike defaulting on a credit card — whose penalties amount to late fees and a lower credit score — defaulting on a home equity loan or HELOC could allow your lender to foreclose on it.
One major advantage of debt financing is that you won't be giving up ownership of the business. When you take out a loan from a financial institution or alternative lender, you're obligated to make the payments on time for the life of the loan, that's it.
