Knowledge Base: Debt & Equity Tutorials

Debt & Equity are the main two “traditional” financing methods for companies.

When a company raises “Equity,” the investors get an ownership stake in the company, so they are entitled to any dividends the company issues, and they can sell their stake to other investors.

If the company grows significantly or does something to increase its value substantially, these Equity investors benefit directly because their shares in the company increase in value.

With Debt, by contrast, the investors do not get an ownership stake in the company and do not receive dividends, but they do receive interest payments from the company over time.

For example, if a company issues $1000 of Debt at a 5% interest rate, the Debt investors (the lenders) earn $1000 * 5% = $50 in interest per year.

Equity investors tend to focus on the upside and growth potential in companies because they want their shares to be worth as much as possible.

Debt investors, since their upside is capped at the interest rate, tend to focus on the downside risks and how likely they are to lose money (e.g., if the company goes bankrupt or defaults and fails to make the required payments).

Debt is generally cheaper than Equity because the interest rates on loans are below the average annualized returns that most Equity investors expect or target; also, the interest paid on Debt is tax-deductible (at least up to a certain level), while dividends paid to Equity investors are not.

This page has links to our tutorials on Debt and Equity-related topics, from bond yields to IPOs and debt vs. equity analysis.