Raising Capital for Your Business? Debt or Equity?
- Garni Gharekhanian
- Aug 19, 2017
- 2 min read
For the new entrepreneur who needs to raise funds, one important question is how to source such capital. There are many advantages and disadvantages to each approach.
Advantages of debt financing:
Speed. You can get funded in days, assuming that your business is already generating significant revenues. If you have good personal credit, significant revenue, and/or collateral, you should get funded within a month at the latest.
Simplicity. There are significant legal and accounting fees associated with equity investments. Such agreements are generally lengthy and there are significant compliance expenses.
Cost. If your business grows significantly, you will have to pay more to the investor than you would pay to a lender (bank or private lender).
Tax treatment. Interest on debt is a deductible business expense, compared to the share of the profit or liquidity (liquidating distribution) expected by an investor.
Control. Want to hold your business and eventually pass it on to your children? Pass up the VC/Equity capital. They will expect a trade sale (i.e. Merger/Acquisition) or IPO (initial public offering). Until then, they will likely insist on a board seat and they will be your boss.
Advantages of equity financing:
Risk. Others share the risk with you. If the business fails, then you will not have to pay the investor back (unless there is fraud involved, in which the investor can sue you).
Connections: Investors may have a wealth of knowledge and connections to share with you.
If your business is already generating significant profits, then raising debt capital is the much better option.
Royalty-based financing, which involves a percentage of revenues and a cap or term, is technically debt, but the periodic payments depend on revenue. It’s effectively a hybrid of both, taking elements from both equity and debt finance.
DISCLAIMER: I am neither a CPA nor an attorney. None of this is to be construed as accounting, tax, or legal advice and/or a substitute for the advice from a CPA or attorney. For further information and advice that is appropriate for your situation, please consult a CPA and/or attorney.
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