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Start-Up Financing: Debt vs. Equity – Part Three: The Bright Side of Equity

JB — Thu, 09 Apr 2009 03:25:56 +0000

Alright so I’ve painted equity financing with a pretty negative brush so far. I’m not trying to make it sound evil, I only want to pound home the point that it isn’t the be-all and end-all of financing, and that entrepreneurs looking to launch start-ups should seriously consider both options and choose which one is best, instead of just automatically focusing on raising capital by selling equity. So are there any positive aspects of equity financing? There certainly are!

First of all, and most importantly in my opinion, equity financing can bring highly valuable knowledge and experience on board. If you can obtain an investor with relevant knowledge or experience in the field of your start-up, or even just in general business, it can be one of the best moves your company can make. When an investor comes on board, they put their money on the line and take a vested interest in seeing your company succeed. You could stand to benefit a lot by having someone on board with enough knowledge, experience or connections to help your business get off the ground. That person or group could end up being your company’s most valuable asset.

Secondly, as mentioned earlier, equity investment doesn’t come with the nagging possibility of going broke and being stuck having to pay back a lender. Anyone who comes on board as an investor will generally do so fully understanding that they’ve assumed the same risk you have, which is that the possibility of failure is ever-present. Knowing this can be comforting in the start-up stages when things are unstable, especially if you’ve decided to go into business in a risky field. Keep in mind though, the riskier the business, the bigger a piece of the pie the investor will likely ask for in exchange for their investment dollars.

So there are definitely very real advantages to equity financing, and it very well may be right for you. The purpose of this series of posts was simply to get you to realize that debt financing also has a set of very real upsides. Neither debt nor equity is superior to the other, they’re simply different. As such, it’s important that you thoroughly investigate your options with both when looking for capital for your business. Don’t just jump on the equity train because it seems to be the popular choice. The benefits of debt (benefits of debt…that just sounds strange) may very well make it the choice for you!

Start-Up Financing: Debt vs. Equity – Part Two: Considering Debt Over Equity

JB — Thu, 09 Apr 2009 03:23:29 +0000

So why exactly should you strongly consider debt financing as opposed to equity financing? After all, everyone knows debt is bad, right? No one likes to owe someone else money, so why not take the route that will allow you to avoid that! There are a few very good reasons.

Firstly, while debt may seem expensive, the cost of borrowing can be, for the most part, considered a short-term cost, at least for start-ups. The debt you’ll be taking on will not likely be on a term of more than a few years. On the other hand, equity financing is forever. When you sell someone part of your business, it’s for good. The only way you can get that back is to buy it back. Consider that and you may come to realize that equity financing can in fact be far more expensive than debt financing when you look at the long term.

If you assume you can build a successful business (a big assumption for most, but humour me), then looking at the cost across the lifetime of your business paints a very different picture than the short term view. In the long term, years after you’ve become successful, that debt you took on to get off the ground will be a distant memory. On the other hand, that chunk of the business you sold will still be in someone else’s pocket, and they’ll have a claim to a piece of your profit pie year in and year out.

Secondly, debt financing leaves control of your business in your hands. You’re responsible to repay that debt, plus the interest, but the lenders generally won’t get in your hair about how you run your business (unless things get really bad). This is a huge advantage. When you raise capital by selling equity, you now have a responsibility to a shareholder or partner. And if that shareholder takes on a large chunk of ownership, you can bet they’re going to want to have a say in how things get done. Rightfully so, too! They’ve put their own money on the line, and they deserve a voice in how things get done.

This might not sound so bad, and in some cases it isn’t, but in some cases, it can be awful. You may take on an investor who you soon find out doesn’t share your vision, decides they don’t believe in your abilities, or are just a general pain in the ass. And you’ll be fully accountable to that pain in the ass! Debt financing on the other hand doesn’t bring with it the possibility of losing control of your own company.

So when is equity financing a good way to go? Check out Part Three of Debt vs. Equity to find out!

Start-Up Financing: Debt vs. Equity – Part One: Is Equity All It’s Cracked Up to Be?

JB — Thu, 09 Apr 2009 03:20:25 +0000

When it comes to the initial stages of your start-up, the odds are you’ll need more money than you have sitting in your bank account. The question then becomes how do you go about procuring that money? The two options are debt financing and equity financing. Equity financing is a popular financing option among a lot of entrepreneurs, especially in start-up stages when the business is unproven. It may not be all it’s cracked up to be though when you consider the long term implications of financing your business by selling equity.

In case anyone reading this is new to the topic of financing, a quick definition of each is in order. Debt financing is pretty self-explanatory. You need money for your business, so you take on debt to get it. The most common method is through a loan. In equity financing, instead of taking on debt, you essentially sell part ownership of your business to an investor. They give you the money you need, and in exchange they take ownership of a certain percentage of your business.

So why is equity financing so popular?

The main reason is that in a way it can be a bit of a get out of jail free card. If you take on debt to finance your business, and something goes wrong and the business goes belly up, you’re still on the hook for the repayment of that debt. With equity financing, the investors take on that risk when they decide to put money into your company. If your company fails, it’s a loss the investor(s) share with you, and you’re not obligated to repay them their investments.

Another reason is that the cost of borrowing is expensive, especially right now with banks being so reluctant to lend. If you are able to find a lender, which will be very difficult to begin with, the interest they’ll demand will likely be significant. This turns off a lot of capital seekers simply because they look at the cost of borrowing and how much interest they’ll owe the lenders, and decide they’d rather go the equity route, where they’ll owe no interest payments.

Equity sounds like the way to go! Or is it?

Well as with a lot of things in business, particularly in entrepreneurship, the answer is it depends. I won’t be so ignorant as to try and say one way or the other is the correct way to go, but I would like to advise that business owners seriously consider the DIS-advantages of equity financing before they decide to sell off ownership in their company.

Go to Part Two of Debt vs. Equity to examine why debt may be a much better option for you than equity.