Financing a business

• Debt:

  • Used as a loan and the creditors (bank) can only claim the loaned amount plus interest
  • Much less involvement since there is no ownership sharing (bank does not have a say)
  • Fixed/pre-determined cost of capital
  • Creditors don't receive any voting right
  • No dividend is paid (interest is earned from loans)
  • No share of profits
  • Irrespective of earning profits or incurring loss, debt holders need to be paid
  • Payment must be first
  • Creates leverage (control)
• Equity:

  • Sharing the ownership of the company with individuals which allow them to receive diviends and voting rights
  • more involvement because equity financially is all about sharing ownership
  • Cost of capital is not fixed - can be negotitated
  • Equity holders receive voting right
  • Dividend is paid whenever the company decides
  • Profits shared through dividends
  • Unless the company makes profit, the quity shareholders don't get paid
  • Payment is last
  • Does not create any leverage
• Loan:

  • an agreement to borrow a set amount of money that needs to be repaid within a certain period of time (term). The term of the loan can vary. Anyone that borrows money will need to pay interest.
  • Interest may be a fixed rate where the interest rate is locked for the term or a variable rate, where the interest may go up or down.
• Secured loan - where the borrowers offers an asset as security (e.g car or house) for a loan. If the loan is unpaid, the lender has the right to sell the security. The interest is lower for this type of loan.
• Unsecured loan - the borrower does not need to have an asset to offer as security. The interest rate however is usually higher.