Debt and equity financing differ in the type of instrument used to raise capital. Equity financing issues shares, while debt financing issues bonds. Both generate cash but attract different investors, with equity investors seeking ownership and bond investors seeking guaranteed returns. Debt financing is less risky for investors.
The main difference between debt and equity financing is the type of instrument the business issues to raise the capital it needs. With equity financing, a company raises capital by issuing shares. In debt financing, the company issues debt instruments, such as bonds, to raise funds.
Both debt and equity financing are means that a company or business can use to raise the money needed for expenses, a special project or other business expenses. Both debt and equity financing generate cash for the company, but by different means. The two different instruments also tend to attract different investors.
When a company issues equity loans, the individual or company buying the stock becomes an owner of the company. In such circumstances, the shareholder owns equity or ownership in the company. The more shares the person holds, the greater their ownership interest in the company. An individual who invests in stocks tends to desire the ownership interest in a company and wishes to choose when and whether to give up ownership.
When a debt instrument is used to raise cash, the company issuing the debt is also required to pay interest on the debt instrument to the bondholder. The challenge with debt financing is that the interest rate on the instrument must be high enough to entice buyers to buy. Also, the riskier the liquidity need, the higher the interest rate on the debt instrument must be in order to attract the number of investors the company needs to raise the necessary capital.
Someone who invests in bonds is typically more of a conservative investor than a stock investor. A bond investor is also present for the life of the bond or until the bond matures. This means that the bond buyer knows when he will receive the return on his investment. Bond yields are also guaranteed, while none of that is the case when someone invests in stocks.
Shareholders may not receive a return on their investment as stock prices fluctuate. While bond prices fluctuate when someone buys a bond, interest payments and the bond’s face value are guaranteed when the bond matures. The level of risk is another difference between debt and equity financing: Debt financing is less risky for investors than equity financing.
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