In this post, I am going to talk about a very important concept. Which is related to fundraising and investment. Whenever you buy an Asset. you want to buy a car or a house. For that you need funds. Similarly, if you want to invest in a project or in a business. Even in that you will require funds. Broadly, If we see any fundraising or investment is divided into two parts. One is Equity and the other is Debt. Now let's talk about fundraising here. If you want to invest anywhere. Still you have two options. One is an equity investment and the other is debt investment. So in this post, we will understand this whole concept. That's how equity and debt work. At the same time, we will also look at some specific things. Suppose if you start a business, then how can you apply equity valuation in it, how can you raise debt funds? How to raise equity funds? You can understand this concept very well.
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| Equity vs Debt Fundraising for Startup and Business |
Meaning of Equity and Debt
So let us understand equity and debt from an example. If I had to define in general As for equity, I would say that it is ownership. If you invest in an asset or invest in a business. So the amount of your portion that is owned within it, we call it equity. If we look at its technical definition, equity = assets - liability. Don't get too confused. I will explain this to you with an example. Suppose you buy a car. The car is worth Rs.10 lakhs. You may not make the full payment by yourself. Maybe you took a loan of seven lakhs on it. People generally buy cars like this. You make a down payment of Rs. 3 Lakhs and you put this money out of your pocket. So under this, you have taken a loan of seven lakhs. We call it Debt. Because you have to pay back the amount with interest to the bank or from whichever financial institution you have taken your loan from. The down payment money, we call it ownership, has become your equity. You will have 30% equity in this vehicle. Because you have given three lakh rupees out of Ten Lakhs rupees. So as you go on paying off the loan, your equity will increase. After 1 year, suppose you have a loan of six lakhs. So the equity you have in that case will become worth four lakhs. Meaning that the equity or ownership you have, at that time will be around 40% equity.
Similarly, you can apply this concept for any business for any asset. Now let's take an example of business. Suppose you want to start a restaurant. So there are different assets in the restaurants. You can take any business example, not only restaurants. So in which type of assets do you have to invest? First of all, you have an idea of what type of restaurant you will run. What types of machinery will you need? What human resources will it take? Then how much capital will be required, how much cash amount will you take? So these are all your assets. Now how much will your total cost be? that you can calculate. Let's say you estimate that it will take you a total of 1 crore rupees to start a restaurant. Now maybe you have three partners and suppose each partner can arrange 20 lakhs each. If you arrange 20 lakhs by yourselves. So even if you have arranged 60 lakhs. So the rest of the 40 Lakhs you still have to raise. So it may be that you can take a loan of 40 Lakhs, you can approach any bank, then you can get a loan of 40 Lakhs. So when you start this restaurant, basically your equity is worth 60 lakhs. And the rest of the loan that you took for 40 lakhs has become your debt. So we will say that you have 40 percent debt and 60 percent equity. So the value of your total assets becomes your one crore rupees. Now let's go ahead, maybe this business of yours will grow and in the future, you may have 5-6 restaurants. Now you will think that we need more money.
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Investment Raising
Now we have to invest because we want to grow it fast. We want to run 40 restaurants instead of 4 restaurants. So you estimate that let's say you have a requirement of Rs. 2 Crores. So if you want to raise investments worth Rs. 2 crore. So you have to calculate the valuation of this company. You can't say that 1 crore × 4, then 4 crores is the valuation. It doesn't work like this. Now basically the valuation you will take will be on the future potential? Let's assume that we put a valuation of 10 crores on this company. Now at a valuation of 10 crores, So now we need an investment of two crores. Now we will take an equity investment of Rs. 1 crore. and second, we will get a debt raise of Rs. 1 crore. We will take one crore rupees from the bank. So now that valuation of this company is Rs. 10 Crores. So, you will get the debt of one crore easily from the bank. You will not have to do any share delusion in it. But when you raise equity investments then you have to dilute shares. So let's assume that your 100 % valuation of 100 % shares is 10 crores. Now you want to fundraise Rs. 1 crore here. If Rs. 1 crore equity, then basically you have to dilute 10 percent of one crore equity. 10 percent you'll raise from investors.
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Now you will think that if you want to do 10 percent delusion. So you will find 10 investors. Which will take your 1 percent equity each. Total 10% equity will go to them. Now what will be the value of this 10% equity obviously, it will cost Rs. 1 crore. So this is 10 investors, how much money they will invest, they will invest Rs.10 lakhs each. 10 X 10 your investment of Rs. 1 crore will be raised. So there will be an equity raise of Rs. 1 crore. Equity of 10 percent i.e. Rs. 1 crore is raised. Then what will happen in this case 10 investors have got 10% of your equity. So how much is left with the promoters, 90% is left with the promoters Now there were three partners so that means 30 percent of each. Then what will happen in this case that what happens in equity investment? That your shares get delusional, But you don't have to return this money. So here you have raised an investment of one crore with equity of one crore. You do not have to return this money immediately. But as you grow your company, the value of your share will increase. So those who are investors can earn their money by selling those shares. You don't need to pay investors. But when you raise this debt of one crore. Whatever interest you will have in it, You will have to pay off that to the bank. So this is the difference between debt and equity. So like I said equity money you don't have to return directly to investors but whatever the debt's money is, whoever is the lender or the bank, with the interest you have to return the money. So here is your basic concept of equity and debt. I hope this concept is clear to you after reading this post.
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