Equity is boon for both investors and investees and scores over debt in several ways. Surprised, see how and why?
For Investees:
Debt comes at a predetermined rate of interest and repayment terms. Mostly, interest has to be paid at monthly intervals and principal with monthly or quarterly rest, as the case may be.
Often, the investee or the management has to struggle for generating quick cash to meet the payment deadlines. At times, they have to delay the payment to creditors or offer discount to customers for early payments. In general, the hidden cost in delayed payment to creditors and discount to customers is more than the normal rate of interest.
Equity provide a perpetual fund free from pressures of generating quick cash flows to pay interest and repay the debt in instalments. The returns by way of dividends is out of profits generated. In case of large surplus cash, buyback option to the shareholders can also be offered. All these repayments are from profits without any timelines.
For Investors:
Though the debt has definite payment timelines reducing the uncertainty of cash flow for investors. But in some cases, the borrowers are not able to meet the timelines and hence the investor or lender face the asset-liability mismatch. This is very much seen by large number of NPAs and write-offs. Further, the lender does not share the success of the borrower.
Equity investment has more risks and there may be more business failures, but equity investor also share the gains made the investee enterprise. The gains made from successful enterprises offset the losses from the failed enterprises.
Thus, an Equity investor share both gains and losses. The debt investor share a part of the losses, but do not share any part of the gains.
However, the debt as well as equity investment should be well-diversified, so that the failure of one enterprise does not wipe out your capital.
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