In this article, we cover the difference between Bond and Equity. Let’s take a closer look at both forms of investment.
In order to scale up your business, financing money is always not an easy decision. Hence to decide between equity and bond could be tricky. Generally, most businesses have two types of funding available: Equity and Bonds.
Equity is one of the ways of raising money from outsiders and in return, you give them a part of the business. Therefore, investors become partial owners of the business and are referred to as shareholders. In addition, the money raised via equity financing won’t need to be paid back to the investors. Unless businesses make enough profits, they are not required to pay dividends. However, this gives them access to the business profits and can exercise their rights in the decision-making process.
For instance, there is a business named Hari Enterprises. They are in need of funds to set up another line of business. After having thought a lot they decide to raise money via Equity Financing. An investor named Monarch Lender agrees to finance 100 million to their business in return for a 25% stake in Hari Enterprises. Over time, Monarch’s lender shares the profits of the business but later on, makes the mind to sell this stake back to the owners. On the other hand, owners now have to pay back more than 100 million on the current valuation of the business.
The second option to raise money will be debt financing or via Bonds. It’s more like a loan you take from a bank. In a similar fashion, businesses can borrow money from outside sources with an agreement they will pay back this money at the agreed maturity date plus the interest over the period. In the case of debt financing, irrespective of the profits or loss made, the borrower has to return the principal plus the interest rate agreed.
For example, this time Hari Enterprises raise money via debt financing. Hence, while raising money they have to declare the maturity date with an interest rate. Let’s say they raise 100 million via bonds. At the time of publishing the circular, it will state the coupon rate, maturity rate, frequency of interest payment. However, investors don’t get any ownership or share in the business apart from the principal and interest.
What is Difference Between Bond and Equity?
Here is the list of differences that you must know before investing in any form of financing.
|Investors get proportional ownership in the company as per the shareholding.||Investors don’t get any ownership in the business instead referred to as creditors to the business.|
|As investors are referred to as shareholders hence they have voting right in the decision-making process.||Investors have no voting rights, unlike equity.|
|Equity has no expiry date investors can hold it till they wish to.||Bonds have a fixed maturity date.|
|Investors share the profits in the form of dividends if the business generates enough money.||Investors are entitled to interest payout as per agreed terms.|
|Capital Appreciation or Depreciation both is applicable as per the performance of the business.||Capital Appreciation is valid for bonds only if it’s a compounding bond. For example, instead of getting a yearly payout, you get this interest on maturity with a compounding factor. Or if the bonds get listed on the stock market.|
|More liquid in nature as they are listed on the stock exchange. Hence investors can easily liquidate the same anytime.||As they come with a fixed maturity date. Therefore, less liquid in nature. In case of investors want to dilute this they need to pay a penalty.|
Recommendation between Bond and Equity
As an investor, if you want to diversify your portfolio, then you should have a mix of Equity and Bonds to balance the risk/returns. However, this two basket of investment is more age-driven. As per the finance basic, when you’re young and more years to see meeting different set of responsibilities. You are advised to invest in equity as it’s a little risker bet. Being young you can take risks to fetch inflation-beating returns. But once you get old, your risk-taking capacity decrease. Moreover, you are in need of regular income to meet the daily need as the source of income becomes less. Therefore, it’s advisable to go for bond investment over equity as it provides interest at regular intervals along with principal at maturity.
Depending upon your risk category you can opt for either form of investment. Moreover, to have a balanced portfolio, ensure you keep the ratio of debt and equity as per your age. In case you are as young as 30 years or 40 years then bond investment to equity investment should be 30:70 or 40:60 or vice-versa. On the other hand, when you get old as 60 years then follow the rule of 60:40.
Hope you like this article, in case you need any investment advice with respect to bonds/equity please do email us.