Two ways to finance a business are private equity and private debt. Choosing what is best for you varies on personal requirements.
- Investment type: Private debt involves lending money to businesses, while private equity involves purchasing ownership stakes in companies.
- Risk and return: Private debt carries a lower risk and provides fixed income, while private equity has higher risk with potentially greater returns.
- Capital structure: Private debt investments are senior in the capital structure, while private equity investments are equity or equity-like instruments.
Private Debt vs Private Equity
The difference between private debt and private equity is the source from which the money is obtained and the extent to which that money is used.
Private equity allows various investors to invest in small, young firms that could be advanced and improved and can later be sold at a high price.
Whereas private debt is a form of loan: informal and formal. The debt does not allow considerable investments in the company, and the profit turns low.
|Parameter of Comparison
|Role of Interest
|These companies look for young firms and undervalued companies to invest in, develop, resell and obtain profit.
|A personal loan, credit card, corporate bond or business loan is taken from individual or private investors.
|It is obtained from private investors and companies who buy small firms
|Debt can be obtained from a relative, friend or even a private company
|After the company or firm has transformed, it catches the eye of various investors ready to make large-scale investments in the newly arising company.
This allows the original equity holders to obtain large-scale profits.
|For investors contributing debt to your company, there may be less incentive to work as hard to grow the business than if the investor was an equity holder. This is because the debt holders are first prioritised to receive funds in the case after liquidation, so they do not have any incentive to grow the business.
|Cash and Other Requirements
|It required a large amount of cash for investment. It requires expertise and skills to evaluate which company is ideal for investing in and the profit that could be obtained from its reselling.
|In this, the company must pay the debt holder along with interest regularly. This leads to severe drainage of cash.
|Liability on Balance Sheet
|Equity doesn’t show up as a liability on your balance sheet. However, you must disclose other equity holders in your financial and corporate documents.
|It is a liability to the company and on the balance sheet. Investors may hesitate to invest in a company with too much harm on its books.
What is Private Debt?
Private debt is the debt accrued by individuals or private businesses. Private debt can be obtained in diverse forms varying from a personal loan, credit card, corporate bond, or business loan.
Private debt is risky because when a loan is provided within the family or between friends, irregular repayments can cause tension and even result in a conflicting relationship.
What is Private Equity?
Private equity has grown significantly in the past 20 years. It is an unconventional investment class comprising assets not listed on a public exchange.
In this, the funds and investors actively invest in private firms. They even take part in the buyouts of public companies. This leads to the disposal of public equity.
A private equity fund has Limited Partners (LP), who usually own 99 per cent of fund shares and have limited liability or zero liability. In contrast, the General Partners (GP) own merely 1 per cent of shares and have entire liability.
The primary target of Private Equity funds is a young firm that seems to have a promising future and sound management.
- Private equity is a form of private financing. In this, various investors directly invest in companies, develop them and make huge profits after selling them.
- Private equity is risky and illiquid, and the investors expect a much higher return than the initial investment.
Main Differences Between Private Debt and Private Equity
- Private debt is easier to obtain if there are good relations between people. But to invest in a new firm, a lot of study and examination is conducted.
- The person obtaining the debt is lending others money and living on their cash, whereas the sold firm loses ownership and can no longer claim any rights to it.
Last Updated : 11 June, 2023
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Chara Yadav holds MBA in Finance. Her goal is to simplify finance-related topics. She has worked in finance for about 25 years. She has held multiple finance and banking classes for business schools and communities. Read more at her bio page.