2.3. Equity vs. Debt
The term ‘equity’ has several different meanings, but for the purposes of this wiki, equity means ownership of an entire or part of a business. This can range from ownership of a stall in the market, to owning shares of stock in a company. When investors purchase equity, they pay funds to the previous business owners, who are thus able to invest those funds in real assets as described in the section titled "What is Finance?".
For equity investors such as mutual funds, their return comes in the form of dividends and an expected increase in the value of the investment.
| Pros of Equity for Business | Cons of Equity for Business |
|---|---|
| “Patient Capital,” i.e. longer return schedule |
Higher expected return |
| Friendly to growth | Business must give up ownership control |
| Access to expertise and shared interest (See angel investors) |
Debt, alternatively, is basically raising money through a loan. Virtually every business has more debt than equity (See: Business Literacy Institute for a description of the debt-to-equity ratio).
In the case of banks and other debt providers, their return comes from the loan “spread,” or the difference between the cost of funds and interest rate charged, as well as any fees charged.
| Pros of Debt for Business | Cons of Debt for Business |
|---|---|
| Cheaper than equity | Collateral/Covenants |
| Doesn't involve ceding ownership control |
Immediate repayment schedule, i.e. "impatient" capital |
| Often tax deductible (Provided adequate financial infrastructure exists) |