How do equity and capital differ?

Difference: equity and debt

A company can be financed from both equity and debt. The differences between the types of financing are not always easy to see.

The equity

The part of the assets that is left over after the debt is deducted is equity. For example, equity is invested in the company through contributions from the shareholders.

This shows the ownership shares of a partner. For example, if a shareholder has invested 40% of the equity in the company, he also owns 40% of the company.

The borrowed capital

Basically, borrowed capital represents a company's debts. Due to the temporary provision of capital by banks or other financiers, interest must be paid.

Difference between equity and debt

Equity is a participation relationship, debt capital is a debt relationship. An important difference to the distinction between equity and debt capital is the liability.

Depending on the legal form, the equity providers are liable with all of their personal assets, but at least with their own contribution. However, the lenders are not liable. Equity providers participate in profits, losses and corporate governance, while lenders do not.

Once equity has been invested, the shareholders are integrated into the company for an unlimited period of time, although short-term termination is sometimes possible. Borrowed capital, on the other hand, is limited in time.

Another important difference between the two types of financing is that the interest on equity is not tax deductible, but the interest on borrowed capital can be fully taxed.

Advantages and disadvantages of equity

Normally higher profits are generated with equity than with borrowed capital. This is mainly due to the fact that the banks demand high security deposits and interest rates for their loans.

Another positive thing about equity is that it is available indefinitely. However, there are also shareholdings in which the equity investor can terminate his contribution promptly.

Another benefit is that companies with high equity often get cheaper loans than companies with high debt.

A disadvantage of equity capital is the equity providers' right of co-determination, as it restricts the flexibility of the existing shareholders.

Advantages and disadvantages of outside capital

One advantage of borrowing is that profits and corporate governance do not have to be shared with borrowers. In addition, the interest can be deducted from taxes.

A disadvantage of outside capital is that it is only available for a limited period of time. In addition, repayments and interest have to be paid even in economically difficult times.

Overall, there are some differences between equity and debt. Only the shareholders can decide for themselves which form is the right one for their own company.

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