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Understanding Debt and Equity

Debt is the amount that you borrow from a person or a financial institution and pay back with interest. Once the amount is paid back, the lender and the borrower have no further dealings with each other. The lender does not provide any support or get involved in your business. Their only objective is to receive their interest payments and all of their money on maturity of the loan.

Debt could be in the form of a fixed term business loan or even a credit card. Most startups do not qualify for business loans unless they can provide the lender, such as a bank, with some security over the loan. This could include a house or other tangible assets. Importantly, you need to be able to service the interest payments with your cash flow and if you are just starting out then your cash flow may be in short supply.

In case of equity, you receive funds from angel investors or venture capital funds and you issue new shares to them, thus providing ownership in your company. For equity investments, you do not have to pay interest and you also do not need to pay back the investor.

The investor receives a return for their investment via dividends (distribution of profits) and when they finally sell their shares, such as following a trade sale of the company to a large competitor or when you list your company on the Australian Stock Exchange via an IPO.

Unlike debt providers, equity investors do get involved in your business and provide support to help you make your business as successful as possible. As they own a share of your company, it is in their interest to make it as valuable as possible.

Debt providers on the other hand do not care how successful your business becomes as long as you can pay the interest and afford to repay the balance owing in the future.

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