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Equity & Debt

. As Barataria has discussed before, business cycles are not only real but heavily define the world in social and technical development terms. These cycles are, in purely economic terms, changes in availability and attitudes towards debt.

It is more than a little chilling to think that progress naturally comes in waves because of something as mundane as debt. But a system defined by money supply which has features that are destabilizing and work against sustainability and resilience is a large part of what we might call “capitalism.” The equilibrium of markets is pushed and pulled by the availability of capital.

One important feature of Fourth Wave Industrialization has to be that these cycles will need to be broken and greater monetary stability has to be achieved for a truly open market. This is likely to mean that equity will have to be favored over debt. But what, really, is the difference?

What is the best way to nourish it?

In broadest possible terms, “equity” is a description of an ownership stake in a company where “debt” is an obligation to pay money back in a defined period of time, usually backed by an asset. In terms of capital raising, it does not appear to be particularly different in the short term. Both are ways of putting something up to get a big wad of cash for the purpose of investment, or in the case of the investor a way of generating an income from an otherwise idle pool of money.

The distinctions between them are critical, however, as the development of a particular business moves forward. Debt requires periodic payments, or interest, that are usually fixed. No matter how well the business is doing, the payments have to be met. Equity, on the other hand, pays out a share of the profit and changes from one period to the next, but requires at the very least reporting and potentially a much more active management system.

This chart is a good summary of the key differences between equity and debt.

Concern DEBT EQUITY
Meaning Funds owed by the company towards another party is known as Debt. Funds raised by the company by issuing shares is known as Equity.
What is it? Loan Funds Own Funds
Reflects Obligation Ownership
Term Comparatively short term Long term
Status of holders Lenders Proprietors
Risk Less High
Types Term loan, Debentures, Bonds etc. Shares and Stocks.
Return Interest Dividend
Nature of return Fixed and regular Variable and irregular
Collateral Essential to secure loans, but funds can be raised otherwise. Not required

In more practical terms, there is not a lot of difference between the two. When debt cannot be repaid, it has to be restructured, or have payments delayed by mutual agreement. Where debt is supposedly not about ownership, it can be enslaving, especially if the interest piles up.

St Peter doncha take me, ‘cuz I can’t go.
I owe my soul to the company store.

Equity at its best is partnership.

That equity places a management role up front is one of its key features, however. Risk management is the essence of investment, and equity is inherently more active and dynamic. Traditionally, a local bank was not only way of securing credit for a business but an active partner even if the terms of the capital were entirely defined as debt with periodic payments. It is one of the features of the system based on smaller community and regional banks that was critical to the development of the United States a century and more ago.

Or, in the words of Warren Buffet, “I don’t invest in anything I can’t see.”

A modern open market operates at a much larger distance, and for that reason has come to favor debt over equity. Management has been left to risk estimates such as an S&P rating or a FICO score that are supposed to be automated. In the first wave of globalism, this appears to make a lot of sense, but it is not a replacement for the nosy community banker who knows the literal business of everyone in town.

Tools for being an active manager at a distance have since been developed, however. It is possible to have a global capital market based on equity stakes operating at a distance. But there are naturally pitfalls, especially when looking at the most common practical definition of equity, which is a stock market.

Management at a distance is hard.

Stock markets supposedly exist for the purpose of creating equity funding. The principle is that equity shares should be tradable as part of the risk management strategy, and that capital appreciation is an important part of expected return as an investment grows in value. In practice, however, stock markets have become less about raising capital and more about keeping score, especially as executives are graded and incentivized by stock prices. The current increase in debt is driven by a desire to raise stock prices by swapping equity for debt.

More importantly, stock ownership comes with little management stake as processes have been developed to block activist shareholders from interrupting the existing executive structure.

What is the future of equity and debt? The two have their time and place, generally, and specific advantages. In a broader sense, however, cycles of debt are a significant social problem. Systems which encourage equity and active risk management through control are likely to grow in popularity, especially when the current debt cycle collapses.

Equity is inherently more respectful of open market forces in too many ways to be ignored.

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3 thoughts on “Equity & Debt

    • Moi? 🙂 Yes, a lot more. This is actually part of People’s Economics. I am convinced that equal access to markets is thwarted by business cycles. Getting out of poverty requires stability, and the lack of it is worth investigating. Given these long-range cycles as a fact, what drives them? If it’s debt, then the use of debt has to be curtailed.

      In the end, I’m re-thinking the entire “time value of money” trope and the concept of interest. I do not want to presume inflation, for example, and I feel it’s built into our system.

  1. Pingback: Coming Out Even | Barataria - The work of Erik Hare

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