A debt instrument is a financial tool that represents a loan made by an investor to a borrower, typically a business or government. It outlines the terms of the loan, including the repayment schedule, interest rate, and maturity date. Common types of debt instruments include bonds, loans, promissory notes, and debentures.
How do debt instruments work?
Debt instruments function as a formal agreement between a borrower and a lender. The borrower receives funds upfront and agrees to repay the principal amount along with interest over a specified period. The instrument defines terms such as interest rate, payment schedule, and maturity date. For startups, this often involves structured repayments that align with their cash flow capabilities.
What is the difference between a debt instrument and an equity instrument?
A debt instrument involves borrowing money that must be repaid with interest, while an equity instrument represents ownership in a company. Debt does not dilute ownership but requires repayment, whereas equity gives investors a stake in the company and potential dividends but does not involve repayment.
Why would startups consider using debt instruments?
- Access capital without diluting ownership. - Cover short-term working capital needs. - Finance specific projects or expansions. - However, startups must ensure they have a clear repayment plan to avoid financial strain.
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