Companies can raise capital via debt or equity. Equity refers to stocks, or an ownership stake, in a company. Buyers of a company's equity become shareholders in that company. The shareholders recoup their investment when the company's value increases (their shares rise in value), or when the company pays a dividend. Buyers of a company's debt are lenders; they recoup their investment in the form of interest paid by the company on the debt.

It is often easier for companies to raise money through debt, as there are fewer regulations on debt issuance, the risk for an investor (lender) is generally lower, and a company's assets can be used as collateral.

## Comparison chart

Debt versus Equity comparison chart
DebtEquity
Brief Definition An amount of money, property, or service that is owed to someone else. How much an asset (something owned) is worth after all debts and other liabilities have been paid.
Example for an Individual Carrying a balance on a credit card. Unless the balance is paid off in full at some point, the credit card company will charge interest on this balance, creating more debt. The value of a home after a mortgage has been paid in full.
Uses For purchasing assets that are more valuable than a party's current ability to pay for them. Can be traded for equity and other advantages by companies. For estimating potential gain in any asset transaction, and for use as purchasing power. Can be traded for debt and other advantages by companies.
Types Secured/unsecured, private/public, loan, bond. Contributed capital, gained capital, revenue.
Calculation (Amount Owed - Value of Asset) (Value of Asset - Debt)
Cost Formula Rd (1-tc) [where Rd is cost of debt; tc is corporate tax rate.] Re = rf + β (rm – rf) [where Re is cost of equity; rf is the risk-free rate; rm is the expected market return; β is equity beta.]
Tradable Yes Yes

## How to Raise Capital

Secured loans are commonly used by businesses to raise capital for a particular purpose (e.g., expansion or remodeling). Similarly, credit cards and other revolving lines of credit often help businesses make everyday purchases that they may not be able to currently afford but know they will be able to afford soon. Some companies, particularly larger ones, may also issue corporate bonds.

Raising capital with equity is known as equity financing. Company shares are sold to others who then gain an ownership interest in the company. Smaller businesses who take advantage of equity financing often sell shares to investors, employees, friends, and family members. Larger companies, such as Google, tend to sell to the public through stock exchanges, like the NASDAQ and NYSE, after an initial public offering (IPO).

An important part of raising capital for a growing company is the company's debt-to-equity ratio — often calculated as debt divided by equity — which is visible on a company's balance sheet.

## Debt vs. Equity Risks

Any debt, especially high-interest debt, comes with risk. If a business takes on a large amount of debt and then later finds it cannot make its loan payments to lenders, there is a good chance that the business will fail under the weight of loan interest and have to file for Chapter 7 or Chapter 11 bankruptcy.

Equity financing avoids such risks and has many benefits, but giving others an ownership stake in a business can be risky; the less valuable a business is, the more ownership an investor might demand, a fact that may prove costly. Moreover, equity financing is tightly regulated to protect investors from shady operations, meaning that this method of raising capital is initially expensive and time-consuming with the need to involve lawyers and accountants. As such, debt is a much simpler way to raise temporary or even long-term capital.

However, raising capital with debt is not always possible. During recessions, credit can be hard to come by as banks become reluctant to lend money or only loan money at very high interest rates. In the 2008 financial crisis, for example, small businesses were often denied credit and forced to seek equity financing options.[1]

## Tax Implications

Debt can be appealing not only due to its simplicity but also because of the way it is taxed. Under U.S. tax law, the IRS lets companies deduct their interest payments against their taxable income. This reduces a company's tax liability.

In contrast, dividend payments to shareholders are not tax deductible for the company. In fact, shareholders receiving dividends are also taxed because dividends are treated as their income. In effect, dividends are taxed twice, once at the company and then again when they are distributed to the owners of the company.

## Legal Implications

Selling debt — i.e., issuing bonds — is relatively easy, especially if a company has previously proven its stability and overall creditworthiness. Selling equity, however, is difficult and costly, largely due to regulations imposed by the U.S. Securities and Exchange Commission (SEC).[3]

## References

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