Difference between Debt & Equity

Many small business owners don’t fully understand the difference between debt and equity funding. Financing your business with debt as distinct from equity has significant implications which you need to fully understand. This table highlights the key differences between debt and equity.

 

DEBT EQUITY
You only ever have to repay the principal amount Return will vary depending on the value of the business
Doesn’t share in trading losses Shares in any trading losses
Guaranteed to get paid interest at an agreed rate and date. Return is therefore fixed. Only gets a dividend if there are profits left after paying all bills and taxes. Return is therefore variable.
Usually has security over assets Has no security
Ranks ahead of shareholders in event of wind up of business Ranks after all creditors in event of wind up of business
Can demand to be repaid if company defaults Can’t demand to have equity repaid but shares can be sold.
Debt provider is a Stakeholder Equity holder is a Partner
Has a definite end period (expiry date) Has no end period
Usually only available once business has been established Usually needed to fund the establishment of a business

And getting the right balance between debt and equity is also critical. Most businesses are established using equity because banks are unlikely to provide debt against a new business which has no track record of performance unless of course you are able to offer the bank some property as security. But this is in a sense equity because you are gearing up on the equity in your house. Once your business is established ie you are generating a consistent and maintainable level of profits, the banks will be more inclined to provide debt to enable the business to grow.

There is no “right” mix of debt and equity. If you are able to get more debt into your business the returns on your own equity invested are magnified but the more debt you take, the more risk you also take.

Now follow the other Resources tabs to read about where to get debt, equity and grants plus the page on “Other Useful Links”.

 

 

 

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