Kevin Neal: The Key Differences Between Equity and Debt Capital

Running
a business usually requires a significant amount of capital. Capital takes various
forms, from economic capital to human and labour capital.

The
term ‘financial capital’ is usually associated with money. Financial capital is
often represented by cash, assets and securities.

Cash
in the bank can make all the difference to the future of any venture, enabling it
to grow and expand. In its absence, companies are often left behind.

Companies
use two different forms of capital funding: equity and debt. Effective
corporate finance strategies determine the most cost-effective mix.

Equity
Capital

Equity
capital is generated by selling shares in company stock. Shares fall into two
distinct categories: common and preferred.

Individuals
who own common shares have voting rights, though in terms of ownership, they are
at the bottom of the ladder. If the company liquidates, other shareholders and
creditors are paid first.

Preferred
shareholders are guaranteed payment of a specified dividend, taking precedence
over payments on common shares. In exchange for financial security, preferred
shareholders have limited ownership rights and forego voting rights.

The
primary benefit of equity capital is that companies are not obliged to repay
shareholder investments. Instead, shareholders receive a return on their investment
according to the company’s performance. These returns take the form of stock
valuations and dividend payments.

Equity
capital does have some disadvantages. Firstly, ownership of the company becomes
diluted, since each shareholder effectively owns a small stake in the company.
Business owners are beholden to shareholders. They have a responsibility to
ensure the company maintains profitability, elevates stock value, and maximises
dividend payments.

Debt
Capital

Debt capital is also known as debt refinancing. For
a company to utilise debt capital, it will usually borrow money from an
investor, agreeing to repay it at a later date. Common forms of debt capital
used by companies are bonds and loans. Companies use these forms of borrowing
to finance new projects or expand the company.

Credit cards are a form of debt capital that are
often used by smaller businesses or early start-ups.

Companies seeking to raise funding through debt may apply
to a bank for a loan. Here the company is the debtor and the bank is the lender.
The company compensates the bank for providing funding by paying interest on
top of the original amount borrowed.

Another form of debt capital is corporate bonds.
They are sold to investors and mature after a set date. Up until the maturity
date, the company has a responsibility to issue investors with regular interest
payments. Because bonds attract a comparatively high element of risk, with
increased chances of default, they tend to pay a higher yield.

Debt capital has several disadvantages. While it is
an effective method of raising capital, it attracts a significant expense in
the form of interest. Interest payments must be made to lenders irrespective of
company performance. In a poor economy or low season, debt payments may exceed
the revenue of a highly leveraged company.

Important Considerations in Raising
Capital

Entrepreneurs need funding to establish and grow
their business. At some point, all businesses need to raise capital. In days
gone by, this usually came in the form of a bank loan, or perhaps investment
from a wealthy family member. However, in today’s internet age, corporate
funding takes a wide variety of different forms, from crowdfunding and venture
capital to microfinance.

Business owners need to be clear about what company
rights they are prepared to surrender, and which they are determined to keep.
The good news is, with such a wide variety of different funding options to
choose from, finding the right investment option for a new venture is easier
than ever before.Kevin Neal serves as Distribution Director for Bluefin
Capital (Luxembourg), overseeing wealth management and distribution across the
company’s Luxembourg, Dubai, and Far East operations. As a former Independent
Financial Advisor, Mr Neal has extensive experience of various
aspects of the money markets, including corporate finance. Mr Neal is a large
shareholder in La Sala Group (Spain), an organisation that specialises in hospitality
and entertainment.