Aspect | Owner's Funds (Equity) | Borrowed Funds (Debt) |
Source of Funds | Represents funds contributed by the owners or shareholders of a company | Comprises funds borrowed from external sources such as banks, financial institutions, or bondholders |
Ownership Stake | Represents ownership in the company and reflects shareholders' equity | Does not confer ownership rights; lenders are creditors with a claim on the company's assets |
Risk and Reward | Owners bear both the risks and rewards associated with the business | Lenders primarily bear the risk of non-repayment, while the company retains profits |
Control and Decision-Making | Equity holders often have voting rights and influence over business decisions | Lenders generally have no influence over the company's day-to-day operations or decision-making |
Dividend Payments | Dividends are paid to equity holders if the company is profitable and chooses to distribute profits | Interest payments are made to lenders as per the terms of the borrowing agreement, regardless of profitability |
Repayment Obligations | No obligation for repayment, except in the event of liquidation or share buybacks | Involves repayment of principal amount along with interest, as specified in the loan agreement |
Impact on Financial Ratios | Equity does not create financial leverage and has no interest cost | Debt introduces financial leverage, increasing interest expenses and affecting financial ratios |
Risk Tolerance | Owners typically have a higher risk tolerance since they share in the business's risks and rewards | Lenders, as creditors, have a lower risk tolerance and expect regular interest payments |
Control Over Assets | Owners have a direct claim on the company's assets and can influence their use | Lenders have a claim on assets only in the event of default and rely on collateral or covenants for control |
Voting Rights | Equity holders often have voting rights in corporate decisions, depending on the type of shares held | Lenders generally do not have voting rights or influence in company decisions |
Profit Participation | Shareholders participate in profit-sharing and benefit from business growth | Lenders do not participate in profit-sharing but receive fixed interest payments |
Risk of Loss | Owners can potentially lose their entire investment if the company faces financial difficulties or goes bankrupt | Lenders are at risk of not receiving the principal or interest if the company defaults on debt obligations |
Legal Rights | Equity holders have residual rights in the company and may receive dividends after debt obligations are met | Lenders have contractual rights, and their claims are legally enforceable |
Dilution Risk | There is a risk of equity dilution if the company issues additional shares to raise capital | No dilution risk, as debt does not dilute ownership |
Liquidity | Equity investment is typically less liquid, and owners may need to sell shares in the open market | Debt instruments can often be traded in secondary markets, offering greater liquidity |
Tax Considerations | Dividends paid to equity holders may be subject to taxation | Interest payments on debt are often tax-deductible, providing a tax shield |
Financial Independence | Equity financing can lead to greater financial independence as there are no mandatory repayments | Debt financing involves periodic repayments, affecting financial flexibility |
Return on Investment | Equity holders participate in the company's returns and capital appreciation | Lenders receive a fixed interest rate and do not share in capital gains |
Leverage | Equity does not introduce financial leverage and does not magnify returns or losses | Debt financing introduces leverage, potentially magnifying returns or losses |
Use of Funds | Owners' funds can be used for various purposes, including investments and operating expenses | Borrowed funds are often earmarked for specific purposes and must be used accordingly |
Collateral Requirement | Equity does not require collateral | Debt may be secured by collateral, such as assets or property |
Interest Rate Fluctuations | Not affected by changes in interest rates | Vulnerable to fluctuations in interest rates, which can impact interest expenses |
Capital Structure Impact | Increases equity in the company, affecting the capital structure | Increases debt in the company, altering the capital structure |
Risk of Bankruptcy | Owners have a stake in the company's survival and may work to prevent bankruptcy | Lenders may take legal action in the event of bankruptcy to recover their debt |
Equity Issuance Cost | May incur issuance costs when raising equity capital, such as underwriting fees | Involves issuance costs like underwriting fees and interest expenses |
Potential for Profit Sharing | Owners benefit from profit-sharing and capital appreciation | Lenders do not share in profits but receive interest payments as agreed upon |
Control over Financial Policy | Equity holders may influence financial policy and dividend decisions | Lenders may impose financial covenants and restrictions on the company |
