Why companies need money, and the equity-versus-debt choice
The answer
A company that needs money has exactly 2 sources: it can borrow it, or it can sell a piece of itself. Borrowing must be repaid with interest but costs the owners nothing permanent. Selling ownership never has to be repaid, and costs the owners a slice of every rupee the company will ever earn.
Why this costs you money
You own shares in a company. One morning it announces it is raising ₹8,000 crore. The stock falls 6%. You are confused, because the company just got ₹8,000 crore.
Here is what you missed. The company sold new shares to raise that money. Your slice of the company just got smaller. You did nothing wrong and you were not informed in advance, and yet your claim on future profits shrank overnight.
Now take the other case. A different company you own raises the same ₹8,000 crore by borrowing from banks. Your slice does not shrink at all. But the company now owes interest every quarter whether it earns anything or not. If profits fall for 2 years, the interest still has to be paid, and it gets paid before you see a single rupee.
Most investors never check which of these 2 things their company is doing. They read the headline "company raises ₹8,000 crore" as good news. It is not news at all until you know which source it came from. One choice quietly reduces what you own. The other quietly increases the chance that what you own becomes worth nothing. Both are survivable. Neither is free. And the company chose one of them on purpose.
How it works
A company needs money for 4 reasons, and it is worth separating them because they have very different consequences.
- To grow. New factories, new stores, new countries, new products. Money spent today to earn more later.
- To replace. Machines wear out. Software goes out of date. This spending does not grow anything. It stops the business shrinking.
- To operate. A company pays suppliers before customers pay it. That gap has to be funded every single day. This is called working capital.
- To survive. Losses, a bad year, a lawsuit, a lost contract. This is the most expensive money a company ever raises, and the most dangerous for you.
Some of this comes from inside the business. A profitable company keeps part of its profit instead of paying it out, and spends it. That is retained earnings, and it is the cheapest money there is because nobody has to be persuaded to provide it.
When internal money is not enough, the company goes outside. And outside there are only 2 doors.
Door 1: debt. The company borrows. It promises a fixed schedule of interest payments and a date when the principal comes back. The lender gets no vote, no share of profits and no upside. If the company triples in size, the lender is still owed the same amount.
Door 2: equity. The company sells new shares. Nothing has to be repaid, ever. The buyer becomes a part-owner and gets a permanent share of every future profit. If the company triples in size, so does the buyer's stake.
The difference that matters most to you is the queue.
| Position in the queue | Who | What they get |
|---|---|---|
| 1 | Secured lenders | Paid first, from named assets |
| 2 | Unsecured lenders and bondholders | Paid next, from what remains |
| 3 | Preference shareholders | Paid next, a fixed amount |
| 4 | You, an ordinary shareholder | Whatever is left, which is often nothing |
You are last. That is not a flaw in the system. It is the reason shares can multiply and bonds cannot. You accept the last position in the queue in exchange for an unlimited claim on the good outcome.
What it tells you, and what it does not
Knowing how a company is financed tells you how much room it has to be wrong.
A company financed mostly by equity can have 3 bad years and survive them. Its owners are unhappy. Nobody can force it to do anything. A company financed mostly by debt can have 1 bad year and lose control of itself, because a missed payment gives lenders rights that shareholders do not have.
It does not tell you whether the business is good. Some excellent businesses carry heavy debt on purpose, because their cash flows are steady and predictable. A toll road, a power utility and a large bank all carry debt levels that would destroy a software company, and they are not badly run.
It also does not tell you the direction of travel from a single reading. A company with heavy debt that is repaying it quickly is not the same as a company with the same debt that is adding to it. One number in 1 year tells you very little. Read 3 or 4 years in a row.
The decision rule
Judge the financing against the steadiness of the earnings, not against a fixed number.
If cash flows are predictable — subscriptions, regulated tariffs, tolls, long contracts — then debt is a reasonable tool and a high debt level is not by itself a warning.
If cash flows swing with a commodity price, a construction cycle or one large customer, then the same debt level is a serious risk, because the interest does not swing with them.
Unless the company is borrowing to pay interest on money it already borrowed. In that case the analysis stops. That is not financing. That is postponement.
Try this now
Five minutes, on 2 companies you actually own.
- Open your broker app or a stock screening website. Pick 2 of your holdings. Choose 2 from different industries if you can.
- Find the tab called Balance Sheet or Financials. Look for Total Equity (sometimes shown as shareholders' funds, net worth or total shareholders' equity).
- On the same page find Total Debt, or add together Long-term borrowings and Short-term borrowings.
- Divide.
Total debt ÷ Total equity = the debt-to-equity ratio. - Write both numbers on the same piece of paper, next to the company names.
What you should see. Two numbers that are probably nothing like each other.
A ratio below 0.3 means the company is financed almost entirely by its owners. Nearly every rupee of profit belongs to you. A ratio above 1.5 means lenders have put in more than the owners have, and lenders get paid first. A ratio near 0 means the business either generates plenty of its own cash or has never needed to grow quickly.
Now say the sentence out loud for each one: "This company is mostly financed by its owners" or "This company is mostly financed by its lenders." You have just described the single fact that decides how much bad news each of them can absorb.
One warning before you interpret. For a bank or a non-bank lender, this ratio is meaningless, because borrowing money is the product. Skip banks for this exercise.
Three real cases
1. Reliance Industries, May to June 2020 (India) — equity chosen deliberately, at scale Reliance completed a rights issue of ₹53,124 crore, the largest ever in India at the time. A rights issue offers new shares to existing shareholders first, in proportion to what they already hold, so an investor who took up the offer was not diluted. Roughly 3 quarters of the money went to repaying debt. Combined with stake sales in its telecom arm, this allowed the company to declare itself net debt free in June 2020. It chose to shrink the lenders' claim and expand the owners' base. That is the equity door, used on purpose.
2. Jet Airways, April 2019 to November 2024 (India) — the queue, in practice India's oldest private airline stopped flying on 17 April 2019 after it could not pay for fuel or salaries. It had borrowed heavily and had run out of both cash and lenders. The insolvency process ran for more than 5 years. On 7 November 2024 the Supreme Court ordered the company liquidated. Lenders recovered a fraction of what they were owed. Shareholders, sitting at position 4 in the queue, were behind all of them. The shares had traded actively throughout those 5 years, bought by people who had not looked at where they stood in the queue.
3. Boeing, October to November 2024 (United States) — equity as a rescue After a series of production and safety problems, Boeing sold roughly $24.25 billion of new stock and share-linked securities, the largest follow-on equity offering ever completed. Boeing could have borrowed instead. It did not, and the raise was widely understood to be protecting its investment-grade credit rating, because a downgrade would have raised the interest rate on everything it already owed. Existing shareholders were diluted heavily. That was the price of avoiding the downgrade. The choice between the 2 doors is rarely free on either side.
The question that resolves it
A novice looks at a fundraising announcement and asks: how much did they raise?
An expert asks: who now has a claim on this company that did not have one yesterday?
New lenders have a claim that is senior to yours and a fixed size. New shareholders have a claim that is junior to lenders and shares the upside with you forever. The amount raised is the least interesting number in the announcement.
What would make this wrong
If the financing choice did not matter, then 2 companies with identical businesses and identical profits would behave identically under stress. They do not. In every recession, the companies that fail first are reliably the ones with the most borrowed money, not the ones with the worst products.
The honest limits are 3.
First, this framework treats debt and equity as clean categories. Real instruments blur the line. Convertible bonds start as debt and become shares. Preference shares behave like debt but sit in the equity section. The 2 doors are a good map, not the territory.
Second, a low debt level is not automatically good. A company that could borrow cheaply and refuses to may simply be earning too little to justify expansion. Zero debt is sometimes caution and sometimes an absence of opportunities.
Third, the numbers on a balance sheet are a single date. A company can repay debt on 30 March, report a clean figure on 31 March, and borrow again on 2 April. Look at the interest actually paid during the year, in the cash flow statement, if you want the number that is hard to arrange.
In India
An Indian company has 5 main routes to outside money, and they are worth knowing by name because you will see them in announcements.
Equity routes, regulated by SEBI:
- Initial public offering (IPO). The first sale of shares to the public. New money reaches the company only through the fresh issue portion. The offer for sale portion is existing owners selling their own shares, and that money goes to them, not to the business.
- Follow-on public offer (FPO). A further public sale after listing.
- Rights issue. New shares offered to existing shareholders in proportion to their holding. This is the most shareholder-friendly route, because you are invited to keep your percentage. If you do not take it up, you are diluted.
- Qualified institutional placement (QIP). New shares sold quickly to large institutions only. Retail shareholders are not invited and are diluted. This is the fastest equity route in India and the one most often used.
- Preferential allotment. Shares issued to named parties, often promoters or a strategic investor, with SEBI rules on pricing and a lock-in period.
Debt routes: bank term loans, working capital limits, non-convertible debentures (NCDs) and commercial paper for short-term needs.
Two Indian specifics change how you read all of this. First, most listed Indian companies have a promoter group holding a large stake, so a large equity issue dilutes the family too, and families resist it. Second, Indian companies lean far more heavily on bank loans than American ones do, which the next article covers in detail.
In the United States
The routes have different names and one structural difference that matters.
Equity routes, regulated by the SEC:
- IPO, then follow-on offerings for later sales.
- Shelf registration, filed on Form S-3. A company registers a large amount of stock in advance and then sells it whenever it chooses, over 3 years.
- At-the-market offering (ATM). Selling new shares directly into the open market, a little at a time, at whatever the price happens to be. There is no announcement on the day of each sale. A US shareholder can be diluted gradually over months without a single headline.
- Private placement (PIPE), selling to selected institutions.
Rights issues exist in the US but are rare. American companies usually go straight to institutions, which means US retail shareholders are diluted more casually than Indian ones.
Debt routes: bank revolving credit facilities, term loans, commercial paper, and above all the corporate bond market, where a large American company can raise billions in a single afternoon without ever speaking to a bank.
Where they differ, and what that tells you
The real divergence is not the paperwork. It is who the lender is.
In India, a company that needs to borrow ₹5,000 crore mostly talks to banks. Corporate bonds outstanding in India are equal to roughly 18% of the country's economic output. In the United States that figure is closer to 120%. What that tells you is specific and useful.
An Indian company's cost of borrowing moves when banks change their appetite — after a bad loan cycle, after an RBI decision, after a regulator tightens lending to one sector. It can happen to a healthy company because of something that went wrong at an unrelated one. When Indian banks pull back, good borrowers are refused alongside bad ones.
An American company's cost of borrowing moves when the bond market changes its mind, and the bond market prices each borrower separately, every day, in public. A healthy American company can usually still issue bonds during a period when weak ones cannot.
So the same balance sheet carries different risk in the 2 countries. In India, ask an extra question about a debt-heavy company: who lends to it, and how many of them are there? A company dependent on 2 or 3 bank relationships is exposed to those 2 or 3 decisions. A company that can also issue bonds has a second door. During the Indian credit squeeze that followed September 2018, the companies that survived comfortably were mostly the ones with more than one way to raise money.
Carry this
- There are only 2 doors: borrow it, or sell a piece of the company.
- Debt does not dilute you but it gets paid before you do. Equity does not have to be repaid but it makes your slice smaller forever.
- You are last in the queue. That is the trade you accepted for unlimited upside.