The Difference between Debt and Equity Financing

The Difference between Debt and Equity Financing
by Alex Merced

 One thing we emphasize here at LibertyIsNow is the relationship between economics and liberty, and without understanding the two neither can see progress. So today I thought I'd briefly introduce an important concept that will shape much of the debate going forward. Financing just means getting the money you need to make some purchase whether it be car, home, or to start a business. There are two types of financing, Equity and Debt financing.

Equity Financing

Equity Financing is done by selling ownership in something to get the money to buy it. For example let's say I wanted to buy a bike and didn't have all the money make the purchase I can ask my friend for the money and we agree we'll share the bike on certain days. Since we both have ownership in the bike, we both have interest in bikes well being because if the other crashes and destroys the bike we both lose our investment. This is similar to the purchase of Common and Preferred stock of companies.

Debt Financing

Debt Financing is done by borrowing the money, which means the borrower retains sole ownership of what is purchased yet has an obligation to pay the lender the original money borrowed, often with a little extra called interest (the reason they would lend it to you in the first place). In this case if I borrowed money from my friend to buy the bike, he could care less about the condition of the bike cause whether I crash the bike or not I am obligated to pay him back his principal and interest. This is similar to the purchase of bonds from a company.

Most of the world is a debt based economy, we borrow to buy cars, homes, and start businesses. This preference for debt financing is a symbol of many things culturally because people could just as easily share in ownership of cars and homes through equity financing and not have to suffer the burden of debt. This cultural characteristic also ties further importance since it ties people down much more to the value of the currency since debts don't adjust with money supply changes like asset prices do. Was this aspect of our culture something that naturally manifested or has it been pushed to extremes by policy decisions promoting lending and borrowing, something we'll be looking into over the next few posts here at LibertyIsNow.