There are two main pure forms of investment in a company: equity investment and debt investment. The first one is investment with the expectation of the company making a profit; the second one is investment with the expectation of the company being able to repay the debt. They are both viable forms of investment, and are generally considered low-risk investments, but have different components.
Unlike an equity investor, a debt investor loans money to a company in a negotiated lending arrangement. Debt investment is an investment given to a company for expansion, the acquisition of property or other business expenses that require capital. In exchange for the investment, investors expect interest income, as well as the repayment of their initial investment.
For an investor looking for regulated income, debt investment is preferable to equity investment. A negotiated schedule of interest payments, along with loan payments, can be mandated as terms of the investment – giving the investor a reliable source of income. Unlike equity investment which can fluctuate with the success or failure of the company, debt investment is a fixed amount which is paid out by the company.
There is a higher level of security for the debt investor that equity investors do not have:
- If the corporation were to go bankrupt, debt investors have a higher priority level than equity investors. A debt investor may have been given a lien on a property as collateral on their investment.
- If the company closes, the investor can make a claim on that property in the event that it is sold, recouping their initial investment.
It is difficult to say which form of investing is better: debt or equity. An investor should decide for one of the investment options given his risk/return preferences: lower risk (through seniority of debt investment) & lower return vs. higher return at a price of higher risk (in case of equity investment). Hence debt investment has the following trade-off:
- Investing in the debt of a company that fails can mean that your loss is limited – through confiscation of collateral, many times the investment is repaid.
- Investing in the debt of a company that goes global can mean that you generate additional income through the interest payments, but your profits are maximized by the size of your investment – you will never make as much money as the people who invested in the equity.
- A regulated mix of both forms of investing can be a solid method of investing that gives you the best of both worlds.