Private equity and debt are the two ways of financing a business. Each approach comes with its own set of pros and cons when it comes to funding a business. Let’s dig down deeper and do a comparative analysis of what would work better for you.
Private Equity vs. Private Debt
The primary differentiating factor between private equity and private debt is the source from which the money is attained and how that money is used.
When it comes to private equity, multiple investors are allowed to invest in small, growing firms that can be sold later at a higher price. The main aim is to acquire large-scale profit.
Whereas private debt, on the other hand, is merely a form of a loan. This loan can be both formal and informal. The debt would not enable you to make huge investments in the company, and the profit margins are fairly low. Private debts are mostly provided by individuals or a company, depending on the relationship terms between the debtor and creditor.
Role of Interest
In private equity, companies prefer young firms and undervalued companies for their investment opportunities to develop them later and resell them at a higher profit margin.
On the other hand, private debt is taken using a credit card, corporate bonds, or a small business loan from individuals or private investors.
Incentive for Investors
In private equity, once the company or firm has expanded and grown in size or value, it catches the attention of various potential investors who are willing to make large-scale investments in a promising company. This increases the chances of obtaining large-scale profit for the original equity investors and gets them a good ROI.
For investors providing debt to you or your company, the incentive is fairly low. There is no guarantee or motivation here to make the business grow or yield a high profit for the creditor. When a company liquidates, the debt holders are first in line to receive the funds. Hence the overall return is low.
Liability on Balance Sheet
Equity is not counted as a liability on your balance sheet. However, you are supposed to disclose other equity holders in your financial and corporate documents.
On the other hand, private debt is considered a liability on the company and the balance sheet. Investors tend to avoid investing in companies that have too many liabilities.
When looking at business financing, both private debt and private equity play a significant role in the growth and development of new firms. Both work on a profit basis and come with their own risks if you are looking to choose any of these options. Analyze your business growth carefully and see which approach would work better for you in the longer run.