I am neither of these people but I do have an understanding of this! On a basic level: debt finance = you, as a company, are raising money by borrowing (e.g. a loan, such as from a bank, a group of banks or credit fund). equity finance = you, as a company, are raising money by issuing shares (aka equity) to either existing or new shareholders of the company (could be other companies or individuals acting as shareholders). These entities or individuals will pay you money for those shares. Very basic pros and cons: if you give equity in your company, that means you are relinquishing/diluting control of the company as equity in a company often gives you voting rights (or if not voting rights, economic rights). You may have a founder who owns 60% of the equity in the company who does not want to lose their controlling stake for example. You may not want to go for debt if interest rates are high, meaning the payments you make on the loan will be higher. If the company already is struggling slightly, further debt could bring in a risk of insolvency. Moreover, depending on the type of company you are, you might not be able to get a loan to begin with (if you're a really small company, the bank would want to secure it against the personal assets of the founders/owners) OR the loan you can get isn't large enough to cover the amount of capital you need to raise.Could someone please explain the difference between debt finance and equity finance and what the relative advantages and disadvantages are of each type of financing (in the context of PE), but in a way that would be digestible to a lay person. Why would one be chosen over the other? I’m trying to get my head around it and my brain is simply not willing to co-operate with me at all. Please help. 🥲🥲
@Andrei Radu @Amma Usman @Ram Sabaratnam
If you're concerned with debt finance (aka leverage) in a PE context, I suggest researching why leverage is so commonly used in this industry. The short answer is that it boosts returns far more than if you used equity (the committed capital in a PE fund) to finance acquisitions of targets. That's why you'll see ratios of like 70/30 or 60/40 debt to equity ratio. The return on equity is just SO much higher in PE if you use leverage. Part of this is tied to the fact that using debt (and some equity) to finance acquisitions means that a single PE fund can make far more investments using leverage than just using the committed capital of that fund. This is also a reason why PE can be controversial - the debt doesn't sit with the fund or the PE manager or GP....
Hope that helps
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