Debt Verses Equity Financing

One of my readers has recently posed the question “in what cases should a manager look at equity verses debt financing”.  First let’s make sure we understand the difference between the two.

Debt financing is exactly what it says.  Incurring debt (taking out a loan) to finance the start-up or purchase of a business.  You can also take out a loan to grow or expand a current business.  Debt financing can take on many different forms.  SBA loans/lines, traditional business lines of credit/loans, equipment leasing, etc.  You can also find alternative debt financing through vehicles like credit card advance funding, hard money loans and hedge fund loans just to name a few.

Equity financing typically comes from an angel investor, a venture capital firm or the like.  When a group or individual makes a cash infusion into your business in exchange for an interest in your company, it is an equity investment.

Now let’s answer the question.  For the typical small business owner/entrepreneur, equity financing is not an option.  Yes, you can go to friends, family or relatives who may have some cash on hand and want to “invest it”.   And yes, this is a form of equity investment.  But not what I believe the reader was inquiring about.  You may think you have the “next best idea since sliced bread” but in reality you are going to create a small business and create a job for yourself and hopefully reap some profits.  As a rule, equity financiers are not interested in small business unless there is an enormous upside potential.  When I say enormous, I mean ENORMOUS.  I don’t know of an equity investment firm that will even look at a deal for less than $1,000,000 and most of the time its north of $5,000,000.  And that investment needs to be able to create an entity that will grow to eight figures in a couple of years or less.  It’s just not worth their time.  On a regular basis I get clients that want to explore equity financing.  99% of the time I steer them in a different direction.  They don’t fit the criteria.

Further, with an equity investment from an outsider you are going to give up a portion of your company.  In many cases that can be a “controlling” interest.  Face it.  Those with the money make the rules.

Debt financing, on the other hand, is much less complicated.  All one has to do is qualify at the lending institution they choose to do business with.  I won’t go on about this now.   I have written in previous blog entries about various forms of debt finance, both traditional and alternative.  There are so many programs out there.  You just need to find them or go out and hire an expert to find them for you.

So my answer………….

If you have an idea or business that can be taken to the “absolute” masses, or can be replicated (franchised) thousands of times over, go for the equity.  This in itself can be very costly and time consuming but if you firmly believe what you have IS “the next best thing since sliced bread”, GO FOR IT!  If you are going to open a local dry cleaning shop, or be a butcher, a baker or candlestick maker, go with the debt side.

Before you make a decision, search deeply.  Evaluate with your head, NOT your heart.  In the end it will save you a lot of time and money.

As always, I keep my writings as short as possible.  For a more in depth response, send me an e-mail.  I’m happy to help.

Best,

Darrell

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