This site is now an "Amazon Associate", we earn from qualifying purchases.

Kevin Neal: The Key Differences Between Equity and Debt Capital

Image result for Equity and Debt Capital

Running a business usually requires a significant amount of capital. Capital takes various forms, from economic capital to human and labour capital.

The term ‘financial capital’ is usually associated with money. Financial capital is often represented by cash, assets and securities.

Cash in the bank can make all the difference to the future of any venture, enabling it to grow and expand. In its absence, companies are often left behind.

Companies use two different forms of capital funding: equity and debt. Effective corporate finance strategies determine the most cost-effective mix.

Equity Capital

Equity capital is generated by selling shares in company stock. Shares fall into two distinct categories: common and preferred.

Individuals who own common shares have voting rights, though in terms of ownership, they are at the bottom of the ladder. If the company liquidates, other shareholders and creditors are paid first.

Preferred shareholders are guaranteed payment of a specified dividend, taking precedence over payments on common shares. In exchange for financial security, preferred shareholders have limited ownership rights and forego voting rights.

The primary benefit of equity capital is that companies are not obliged to repay shareholder investments. Instead, shareholders receive a return on their investment according to the company’s performance. These returns take the form of stock valuations and dividend payments.

Equity capital does have some disadvantages. Firstly, ownership of the company becomes diluted, since each shareholder effectively owns a small stake in the company. Business owners are beholden to shareholders. They have a responsibility to ensure the company maintains profitability, elevates stock value, and maximises dividend payments.

Debt Capital

Debt capital is also known as debt refinancing. For a company to utilise debt capital, it will usually borrow money from an investor, agreeing to repay it at a later date. Common forms of debt capital used by companies are bonds and loans. Companies use these forms of borrowing to finance new projects or expand the company.

Credit cards are a form of debt capital that are often used by smaller businesses or early start-ups.

Companies seeking to raise funding through debt may apply to a bank for a loan. Here the company is the debtor and the bank is the lender. The company compensates the bank for providing funding by paying interest on top of the original amount borrowed.

Another form of debt capital is corporate bonds. They are sold to investors and mature after a set date. Up until the maturity date, the company has a responsibility to issue investors with regular interest payments. Because bonds attract a comparatively high element of risk, with increased chances of default, they tend to pay a higher yield.

Debt capital has several disadvantages. While it is an effective method of raising capital, it attracts a significant expense in the form of interest. Interest payments must be made to lenders irrespective of company performance. In a poor economy or low season, debt payments may exceed the revenue of a highly leveraged company.

Important Considerations in Raising Capital

Entrepreneurs need funding to establish and grow their business. At some point, all businesses need to raise capital. In days gone by, this usually came in the form of a bank loan, or perhaps investment from a wealthy family member. However, in today’s internet age, corporate funding takes a wide variety of different forms, from crowdfunding and venture capital to microfinance.

Business owners need to be clear about what company rights they are prepared to surrender, and which they are determined to keep. The good news is, with such a wide variety of different funding options to choose from, finding the right investment option for a new venture is easier than ever before.

Kevin Neal serves as Distribution Director for Bluefin Capital (Luxembourg), overseeing wealth management and distribution across the company’s Luxembourg, Dubai, and Far East operations. As a former Independent Financial Advisor, Mr Neal has extensive experience of various aspects of the money markets, including corporate finance. Mr Neal is a large shareholder in La Sala Group (Spain), an organisation that specialises in hospitality and entertainment.

Peer to Peer Lending and Private Lending Info