Comparing Share Capital and Debt Capital: Foundations of Corporate Finance

Under the Companies Act, there are two primary forms of capital that companies can issue and utilize: one is share capital, and the other is debt capital.

Share Capital

Share capital of a company refers to the amount invested in the company for it to carry out its operations. Shareholders who buy the shares become partial owners of the company, sharing in its profits through dividends and potentially having voting rights.

The Share capital can be of two types, equity share capital and preference share capital.

Equity Share Capital

Equity Share capital refers to the funds that a company raises by issuing equity shares in the company. When a company issues shares, it's essentially selling ownership stakes or ownership interests to investors in exchange for capital. Equity share capital may be divided on the basis of voting rights and differential rights (DVR) as to dividend, voting rights.

Preference share capital 

Preference share capital is a type of share capital issued by companies that holds specific rights and privileges not possessed by ordinary shares. Preference shareholders carries or would carry a preferential right with respect to payment of dividend and repayment, in the case of a winding up of the company.

Debt Capital

Debt capital refers to funds raised by a company or organization through borrowing, typically by taking loans or issuing bonds. It's a form of capital that comes with an obligation to repay the borrowed amount, usually with interest, over a specified period.

Debt capital can be raised from various sources:

Loans from Financial Institutions: Companies can borrow money from banks or financial institutions. These loans could be short-term (like working capital loans) or long-term (such as term loans for capital expenditures).

Corporate Bonds: Issuing bonds allows companies to raise funds from investors. Bonds are debt securities with a fixed interest rate and maturity date, and they can be sold to individual or institutional investors.

Private Debt Placements: Companies can also raise debt capital through private placements where they negotiate and sell debt securities directly to institutional investors like insurance companies, pension funds, or private equity firms.

Convertible Debt: This type of debt allows lenders to convert their loan into equity (ownership in the company) at a later stage, usually at the discretion of the lender or under specific conditions.

Debentures: Like bonds, a debenture is a type of debt instrument issued by a company to raise capital. When the company needs to borrow money from the public or investors, it may issue debentures as a form of long-term borrowing. The Company may issue secured or unsecured debentures and with an option to convert it in equity.

Debt capital can be an essential part of a company's capital structure, but it's important to manage it prudently. While it offers a way to raise funds without diluting ownership, excessive debt can lead to financial strain due to interest payments and the obligation to repay the principal amount. Companies often aim to strike a balance between debt and equity financing to optimize their financial structure and costs.

Key Difference between Share Capital and Debt Capital:

Points	Share Capital	Debt Capital
Nature	Share capital represents the ownership interest in a company. When investors purchase shares of a company's stock, they become shareholders and own a portion of the company.	Debt capital represents borrowed money that must be repaid with interest over time. Investors who provide debt capital are creditors to the company.
Source	It is raised by issuing shares to investors through initial public offerings (IPOs) or private placements.	Debt capital can be raised through loans, bonds, or other debt instruments issued by the company.
Return	Shareholders earn returns through capital appreciation (increase in the value of the shares) and dividends (if declared).	Creditors receive fixed interest payments and the return of the principal amount at the end of the loan term. The return is predetermined and not linked to the company's profitability.
Risk and Rewards	Shareholders bear the risk of the company's performance but also participate in its success. They have voting rights in major company decisions.	Creditors face lower risk compared to shareholders, as they have a contractual claim to interest payments and repayment of principal. However, they do not participate in the company's ownership or enjoy potential upside gains.
Obligation	There is no strict obligation to repay share capital. Shareholders are residual claimants, meaning they are entitled to the remaining assets after all obligations have been met in the case of liquidation.	The company has a legal obligation to repay debt capital. Failure to make scheduled payments may result in penalties, and creditors may have the right to take legal action.

Companies while choosing between equity and debt financing should consider several factors such as their immediate capital requirements, risk appetite, existing financial structure, and growth strategies. The goal is to strike a balance between retaining control and meeting financial obligations. Equity financing offers flexibility but dilutes ownership, while debt financing maintains control but requires fixed repayments. By judiciously combining these methods, companies aim to optimize their capital structure, ensuring they have the necessary funds for growth while managing risks and maintaining their operational freedom.