Debt and equity are two of the main ways businesses can access capital to finance growth. While each financing option comes with significant advantages, debt and equity also bring some distinct differences. Understanding the different types of capital and the positive benefits of each can help companies make better decisions about which source to use.

Debt vs. Equity: How They Work

Understanding the differences between debt and equity is helpful in recognizing the benefits of each. Equity is ownership, a stake in the company, typically represented by stock shares. The issuer of equity receives no promise of repayment but instead a share of the company’s future profits and for that, it shares in the risk as well. Debt, on the other hand, is borrowed money, using a promissory note or other agreement to list the terms of repayment, which generally includes interest.

The Positive Benefits of Equity

An often-favored financing source, equity offers some important benefits. Not requiring repayment, it’s a gentler use of capital for the company. Equity does require issuing shares, but by maintaining carefully planned ratios of debt to equity, even small companies can access equity financing funds. Companies using equity may also enjoy improved relationships with investors, who may bring not only capital but also business experience and networks. Finally, the cash injection from an equity stake provides more money for operations and can help propel growth.

The Positive Benefits of Debt

Debt also has significant benefits, both for the issuer and investor. The company issuing debt can benefit from the full amount and an immediate influx of cash. The investor, meanwhile, can benefit from the interest payments, which are usually fixed and offer a more certain return. Debt payments also help companies time payments over the contract period, which affords more flexibility in repayment.

The decision as to whether to use debt or equity ultimately depends on what works best for a company’s individual situation. Understanding the benefits of each, however, can help you recognize the pros and cons and choose the financing that fits.