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Difference Between Debt and Equity

Debt vs Equity

When somebody is looking to expand or start a business, or an individual is looking for some kind of investment or needs money, he needs to find out the sources from where he can obtain the funds. There are two parties; one who gives the funds and the other who uses the funds. Capital can be obtained in the form of a debt, or it can be obtained by buying equity. The source of money you choose to obtain your money from is not the same. The comfort level is different, the rates of return on the money are different, and they have their own advantages and disadvantages. Thus, one needs to be sure about the differences between “debt” and “equity” as it is an ongoing relationship between the one who funds and the one who uses the funds.

Debt
“Debt” is basically a loan obtained from an investor. It is supposed to be paid back in full with interest to the investor irrespective of the fact whether the user’s business is doing well or not. For instance, one has to pay a credit card bill to the bank. The debt is a fixed capital. One needs to start paying the debt once you receive it, and it is supposed to be paid every month. Thus, it adds to the monthly expenditures. When a loan is obtained, one gets money which needs to be returned, but you do not give any kind of ownership of your company or capital to the investor.

The lenders are not a part of the benefits if the company which has obtained the loan starts making profits. Thus, the creditors are very careful in choosing who they lend money to to reduce their risk of not receiving their money back in case the business does not make profits and the loan cannot be repaid. The creditors secure the loans with some collateral for the assets of the company obtaining the loan.

Equity
“Equity” refers to an investment where the investor gets a part of the ownership of the capital or company receiving the funds. The returns in the equity relationship is not fixed. The returns are based on the profits made by the company. When you get into an equity relationship, nothing has to be returned. However, sometimes one needs to give up equity in such large numbers that others get control over your company.

In the case of individual stocks, the one buying the equity gets a portion of the large corporations, and as these companies make a profit, one receives a portion of their profits in the form of dividends.

Summary:

1.Debt has to be repaid with interest; equity can be kept for as long as you want to keep it.
2.For debts, regular interest needs to be paid to the creditor. Thus, there needs to be a continuous cash flow. An equity payment regularly is not required. One may also receive dividends.
3.For debt, collateral assets are required to secure the loan; collateral is not required for equity.
4.The interest payments of the loan are tax deductible; the dividends received are not tax deductible.
5.Debt does not require any control over the company; equity requires control over a portion of the capital or the company.


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  1. Thank you!

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