Let’s discuss How a company borrows money from the market.
When there is a personal need we borrow money usually from a bank or from friends and family.
Likewise, A company can borrow money from private institutions or from the common public. This is known as Capital raising. Only listed companies can raise money from the public. Today let’s focus only on raising capital from the public.
Capital is raised by the company for various needs like for business expansion, reducing debt etc. There are two types of markets where a company can raise money for their needs, which is the equity and debt market.
First let’s see about the Equity market. When the company raises money from the public through the equity market, it actually receives money in exchange of shares of the company. The shareholders who own the shares have a part of ownership in the company .
If the company performs well then value of the shares get appreciated and profits can be distributed to shareholders as “dividends”. If the company doesn’t perform well then value of the shares may reduce and there may be loss in principal invested by shareholders.
The other way to raise money is through the debt market. This is just like borrowing money and then paying it back in the future along with the interest. There are many ways to borrow money through the debt market but for now let’s say that a company goes to a bank and borrows money. Unlike the equity shareholder, regardless of how the business does, the lender (In this case, it is a Bank) gets a fixed interest, for example 9%. Let’s say that a company is doing well and it is having 20% profit. In this case, the equity shareholder gets a dividend amount as profit which will be more than the interest received by the lenders (bank), whereas the one who lends money as debt gets only 9% interest regardless of the profitability. Similarly when the company goes into bankruptcy, the lender (bank) gets back the money first before the equity shareholder.
From the above we can easily understand that Equity shareholders have more risk than the debt lenders.
In short, we can say that if you buy a share of the company then you are the part owner of the company and if you lend to the company in form of debt, then you are just part lender to the company and don’t have any ownership.