Differences between Debt and Equity Capital (2024)

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 investmentEquity 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.

Also See:

Differences between Debt and Equity Capital (2024)

FAQs

Differences between Debt 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 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 are the four main differences between debt and equity? ›

Difference Between Debt and Equity
PointsDebtEquity
RepaymentFixed periodic repaymentsNo obligation to repay
RiskLender bears lower riskInvestors bear higher risk
ControlBorrower retains controlShareholders have voting rights
Claims on AssetsSecured or unsecured claims on assetsResidual claims on assets
6 more rows
Jun 16, 2023

What is the difference between equity capital and debt capital Quizlet? ›

What is the difference between an equity capital structure and a debt capital structure? An equity capital structure would have fewer liabilities than stockholders' equity and a debt capital structure would have the opposite.

Which of the following is a difference between debt and equity? ›

Debt financing involves the borrowing of money whereas equity financing involves selling a portion of equity in the company. The main advantage of equity financing is that there is no obligation to repay the money acquired through it.

What is the difference between debt equity 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 debt funds and equity funds? ›

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.

Why is equity capital more expensive than debt? ›

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).

Why use debt instead of equity? ›

Reasons why companies might elect to use debt rather than equity financing include: A loan does not provide an ownership stake and, so, does not cause dilution to the owners' equity position in the business. Debt can be a less expensive source of growth capital if the Company is growing at a high rate.

Why equity capital is considered riskier than debt capital? ›

Debt financing is generally considered to be less risky than equity financing because lenders have a legal right to be repaid. However, equity investors have the potential to earn higher returns if the company is successful.

What is the difference between debt and equity for dummies? ›

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.

How do you determine debt vs equity? ›

The 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.

What is meant by equity capital? ›

The equity capital definition refers to capital that a company owns that is not tied to debt. This type of capital often involves investor money entering the company in exchange for shares.

What is the difference between debt and equity markets? ›

In the equity market, you buy and sell shares. In the debt market, bonds, certificates of deposits, debentures, government securities are bought and sold. The debt instruments include: Bonds: Both the government and the company, can issue bonds.

What are debt capital markets? ›

Debt Capital Markets Explained: What You Do in the DCM Group. Definition: A Debt Capital Market (DCM) is a market in which companies and governments raise funds through the trade of debt securities, including corporate bonds, government bonds, Credit Default Swaps etc.

Why DCM instead of ECM? ›

ECM serves as the gateway to fresh capital, providing companies with the means to fuel growth, expand operations, or embark on ambitious ventures. Conversely, DCM emerges as the bastion of borrowing, where entities leverage debt instruments to finance endeavors, from corporate expansions to infrastructure projects.

What is the difference between the capital market and the equity market? ›

The stock market deals only with equity capital, while the capital market deals with equity and debt instruments. The stock market exclusively works with corporations regulated by the Securities Exchange Commission (SEC), while the capital market extends beyond regulated securities.

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