There are two options available to every business in the grand scheme of things when selecting a funding method: Equity and Debt. Today we will discuss what private equity and debt are and look at the differences between the both.
Private equity consists of assets that are not listed on a public exchange. Funds are directly invested into a business by an individual or collective group of investors. In some cases, these investors involve themselves in purchasing these companies, which are not listed on the public exchange. Essentially private equity is a form of private financing with the investors having limited liability.
Individuals or businesses obtain debt financing in several ways. It can be a corporate bond, personal loan, business loan, or credit card and can even be obtained from non-banking companies. Debt financing requires the borrower to pay interest consistently and eventually pay off the loan, which is not the case with private equity.
What’s the Difference?
Private equity is sourced by private investors and companies looking to buy smaller firms. On the other hand, Debt can be obtained from a private company, bank, or even your friends and relatives.
Incentives for Investors
As a business starts to gain ground making consistent sales with good margins, nvestors are attracted to getting in on the action. They invest large sums of money, hoping to turn a huge profit if things work out in their favor.
Individuals and companies that offer debt to a business are not too involved in making a business successful. The interest they receive regularly as well capital repayment delivered at the end of the loan term drives them. They are also aware that if the business liquidates, they will obtain their money before others.
Cash requirements for companies that obtain a private equity investment are not so stringent. If the business is struggling, it will most likely not give out dividends. In the case a partner wants to liquidate their investment, the company or individual buying their share must pay them back.
Debt requires regular cash or equivalent asset payments to the person or company who lent the money. This can strain the cash flow of a business. Moreover, debt must be repaid within a specified term, unlike private equity.
Appearance on The Balance Sheet
On a business’s balance sheet, private equity does not appear as a liability. However, it has to be mentioned under other equity in your balance sheet and other documents. Debt, on the other side, shows up as a liability of the business. Companies with too much Debt are a red flag for investors.
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