You’ve likely heard business owners and investors talk about debt and equity. These two ways to raise money for a company come up often. If you’ve ever studied finance, you’ve probably run into the comparison. But not every statement about them is accurate. Let’s break down the real differences—and figure out which statement often gets mistaken for one.
What Makes Debt and Equity Different?
Photo by Mikhail Nilov
Debt and equity represent two very different choices for getting funds. Think of debt as borrowing money—like a loan you pay back with interest. Equity, on the other hand, is selling a piece of your business to an investor for cash.
Here’s a quick list to summarize the differences:
- Ownership: Debt holders do not get ownership or voting rights. Equity holders become owners.
- Repayment: Debt must be paid back, often in fixed payments. Equity doesn’t require repayment—the investor shares in profits and losses.
- Control: Taking on debt doesn’t affect who runs the company. Selling equity usually means new voices can help make decisions.
- Tax Benefits: Interest you pay on debt is usually tax-deductible. Dividends paid to shareholders are not.
- Risk: Debt must be paid whether or not the business makes money. With equity, there’s no required payout if times are tough.
Common Confusion: Trading on Public Markets
One popular belief is that only equity is traded on public markets. This isn’t true. Both debt (like bonds) and equity (stocks) can be bought and sold on exchanges. Companies issue bonds, which are a form of debt, and investors trade them just like they do stocks.
This means: “Equity is publicly traded while debt is not” is NOT a real difference between the two. Both can be traded, and large companies often issue both kinds.
Ownership vs Lending
The simplest way to spot the difference is to ask: “Does this person own a part of the business, or are they just owed money?” Debt holders are like lenders. They don’t own the company; they just want their money back with interest. Equity holders buy a share of the business and hope it grows in value.
- Debt = Lender or creditor
- Equity = Owner or shareholder
That’s why equity holders usually get a vote in major business matters, while debt holders do not.
Repayments and Dividends
When you borrow money, you have to pay it back. Loans and bonds have set schedules for repayment plus interest. Miss those payments, and there are serious consequences.
With equity, the company doesn’t have to pay back investors on a schedule. Dividends are paid at the company’s choice and only if there’s profit. No profit? No dividend.
Key point: Failing to pay interest on debt can lead to bankruptcy. Not paying dividends to shareholders simply disappoints them, but it doesn't create a crisis.
Tax Rules
Here’s a practical example: When a business pays interest on a loan, it can usually deduct that expense from its taxes. Dividends paid to shareholders, though, don’t reduce taxable income.
Interest on debt saves a business money at tax time. Dividends do not.
Which Statement Is NOT a Difference?
Let’s look at several often-cited statements. One of these is NOT a real difference between debt and equity:
- Equity represents ownership interest while debt does not.
- A corporation’s interest payments on debt are tax deductible, but the dividends it pays to equity holders are not.
- Equity is publicly traded, but debt is not.
- Debt holders do not have voting power as shareholders do.
Numbers 1, 2, and 4 describe real, factual differences. But number 3? It’s wrong.
Reality check: Both corporate debt (like bonds) and stocks (equity) are often traded on public markets. Debt isn’t stuck in private hands. It’s just as tradeable—sometimes more so, since big funds buy and sell bonds daily.
Why This Mix-Up Matters
Getting this distinction wrong can create myths about risk and opportunity. Many investors believe only stocks offer liquidity or public access. But bonds are a pillar of public markets, prized for their stability and predictability.
For companies, the ability to issue public debt means greater choice. They might pick debt for some projects—lower cost, no ownership dilution—and equity for others, like when they need to take on higher risk.
A Quick Analogy
Picture a company as a house. Taking on debt is like getting a mortgage. You keep full ownership, as long as you make the payments. Equity is like inviting a partner to co-own your home. If the house grows in value, you split the gains—but you also share decisions.
Key Takeaways
- Debt and equity are both important for financing a business.
- The belief that “debt is not publicly traded” is false. Both stocks and bonds (debt) are widely traded.
- Debt brings fixed repayment and lower risk for the lender.
- Equity grants ownership, voting rights, and a share in profit or loss.
Conclusion
Understanding what truly separates debt from equity is crucial, whether you’re an investor, a founder, or just curious about business. The lines are clear—except for the myth about public trading. Next time you hear that only stocks hit the trading floor, you’ll know better. Both sides of the capital structure play their part, each with unique risks and rewards. Keep this in mind to make smarter financial decisions.