Debt or Equity - Which is Riskiest?

Richard Clarke

When it comes to financing a company, you can use either debt (like loans) or equity (like selling shares).

Who Gets Paid First

Who Gets Paid First: If a company goes bankrupt, debt holders (people who lent money) get paid before equity holders (shareholders). This makes debt safer because lenders are more likely to get their money back.

Debt has Fixed Payments

Debt involves regular interest payments that the company must make, no matter how well or poorly it's doing. Equity, on the other hand, involves dividends, which are not guaranteed and only paid if the company is doing well.

Cost of Money

Borrowing money (debt) is usually cheaper than raising money by selling shares (equity). This is because shareholders expect higher returns to compensate for the higher risk they are taking.

Unpredictable Returns:

Shareholders face more uncertainty because their returns depend on the company's profits, which can go up and down. Debt holders get fixed interest payments, making their returns more predictable.

Financial Risk

Using more debt increases the financial risk for shareholders. This is because the company has to make regular interest payments, which can make earnings more volatile. Shareholders demand higher returns to compensate for this extra risk.

Risk of Bankruptcy

High levels of debt increase the risk of bankruptcy. If the company can't meet its debt payments, it might go bankrupt. In such cases, shareholders are the last to get any remaining money, making it riskier for them.


In short, while debt is generally safer and cheaper, but is  riskier at high levels as bankruptcy risk is higher