Investment, Loans, and Equity: What are the differences? Explain the characteristics, benefits, and points of caution for each.

1. What is investment?:

Investment broadly refers to providing funds to a third party with the expectation of future profits. Originally, investment meant providing capital to companies, but now it is used to refer to the act of providing funds, as described above. Therefore, loans and equity, which will be introduced next, can also be considered as types of investment.

2. What is a Loan?

To answer the question “What is a loan?”, let’s follow this information. Loans entail lending money with the aim of earning interest, and for the party raising funds, it refers to "borrowing." Examples of entities providing funds include banks and other financial institutions. Depending on the borrower, loans can further be categorized into private loans and public loans.

The characteristic feature of loans is the "obligation to repay." This sets them apart from investments or equity, where there is generally no repayment obligation.

3. Equity Investment:

Equity investment refers to investors providing funds to a company in exchange for shares or other forms of ownership, with the expectation of future profits. Funds raised through equity investment typically do not entail an obligation to repay. However, since shares are issued to investors, they gain influence over the company's management. In essence, there is little difference between equity investment and investment.

4. Difference between loan and investment:

What is an investment company? Since investment involves providing funds to a company with the expectation of future returns, loans, and equity can be considered part of investment in a broad sense. Let's examine the main Investment loan differences, including the "providers of funds," "purpose of funding," and "obligation to repay."

So, what is loan investment difference?

4.1. Providers of Funds:

For loans, the providers of funds are typically banks or governmental institutions.

On the other hand, for equity, the providers of funds are primarily investors such as venture capitalists or individual angel investors.

4.2. Objectives of Fund Providers:

Fund providers for loans earn profits by receiving interest as specified in the contract.

In contrast, for equity, the objective is to increase the value of the obtained shares and realize profits upon their sale. Investors focus on the growth potential of the business or enterprise they are investing in. If the company or business grows as anticipated, investors can sell their shares and realize capital gains.

4.3. Obligation to Repay:

Loans involve the obligation to repay the principal amount and interest within a specified repayment period.

Conversely, equity allows the obtained funds to be converted into equity, and generally, there is no obligation to repay.

4.4. Treatment in Financial Statements:

When receiving a loan, it is recorded as an increase in liabilities on the balance sheet.

An increase in liabilities due to loans may negatively impact financial indicators such as the debt ratio, potentially leading to stricter financial checks and monitoring by financial institutions or business partners.

On the other hand, when accepting equity investment, it is recorded as an increase in net assets (equity) on the balance sheet. Now, we understand the difference between investment and loan.

5. Benefits of Financing

Regarding financing, we will introduce the advantages from the perspectives of both the borrower and the lender.

5.1.[For the Borrower] High Degree of Management Freedom and Potential for Large Fundraising:

The lender typically does not intervene in management. Compared to investments or equity, the borrower enjoys a higher degree of management freedom. Additionally, if there are no credit issues, it is possible to raise large amounts of funds.

5.2.[For the Lender] High Probability of Repayment Preservation:

Lenders prioritize the certainty of repayment during the assessment process. Therefore, they extend loans to companies with a high likelihood of repayment. Furthermore, by requesting collateral or guarantors during the loan process, lenders ensure the preservation of their claims even in cases where repayment becomes difficult.

6. Drawbacks and Considerations of Financing:

6.1. [For the Borrower] Obligation for Interest Payments and Repayment:

One significant difference between financing and investment or equity is the obligation to repay. Additionally, besides repaying the principal amount, borrowers also need to pay interest. In other words, they are required to pay back more than the amount borrowed. Moreover, borrowers must undergo evaluations by entities such as banks, which involve preparing necessary documents. If collateral or guarantors are requested, additional documentation is required. These processes involve significant time and effort, constituting drawbacks of financing.

6.2. [For the Lender] Need to Prepare for Risks in Case of Default:

In the event of repayment delays from the borrower, lenders must assess whether future repayment plans can be established. If repayment seems difficult, lenders rely on collateral or guarantors for repayment. However, this process involves complex procedures such as collateral auctions, and it takes time to actually recover funds. Lenders need to prepare for the risk of non-repayment from borrowers.

7. Benefits of investment

Benefits of Equity Investment:

7.1. [For the Recipient of Funds] No Repayment Obligation and Access to Investor Support:

A significant benefit is the absence of repayment obligation, distinguishing it from loans as mentioned earlier. Additionally, investors providing funds often have extensive experience in investing in numerous companies, which means recipients may receive not only funds but also advice regarding management. If the performance of the target company improves, leading to an increase in its value, investors can expect substantial capital gains, making valuable advice more likely.

7.2. [For the Provider of Funds] Focus on Promising Businesses and Expectation of Returns:

The advantage for the investor lies in selecting businesses with growth potential for funding, with the expectation of future growth. Concentrating on businesses with high investment or equity return potential enhances investment efficiency. Moreover, if the business in which the investor has already invested is compatible with the new venture, significant synergy effects can be anticipated.

8. Drawbacks and Considerations of Equity Investment:

8.1.[For the Recipient of Funds] Risk of Decreased Management Freedom:

In exchange for funds received from investors or other fund providers, it is common for companies to issue their own shares. Consequently, there is a risk of reduced management freedom as investors become involved in company management. In extreme cases, investors may control more than half of the voting shares, potentially leading to a loss of managerial control. Moreover, issuing shares equivalent to the received funds means that if the stock price is low, the required amount may not be raised. Additionally, as company performance improves, costs associated with "dividend payments" and "shareholder benefits" are expected to increase.

8.2. [For the Provider of Funds] Possibility of Not Achieving Expected Profits:

Fund providers may not always obtain the expected returns. Besides the risk of business failure, unexpected external factors such as natural disasters or events like the COVID-19 pandemic could deteriorate performance. If a company's performance worsens, dividend payments may be deferred. Furthermore, even if profits are generated, dividends may not be paid out to strengthen internal reserves, requiring careful attention.

9. Conclusion

We have provided explanations regarding investment, including its subtype financing and equity investment.

In the future, when considering fundraising, we recommend taking into account the advantages and disadvantages of financing and equity investment and choosing the fundraising method that best suits the purpose and situation of your company.