Wednesday, February 26, 2014
Start Up Financing Debt Vs Equity Is Equity All Its Cracked Up to Be
When it comes to the initial stages of your start-up, the odds are youll 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 its 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, youre 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, its a loss the investor(s) share with you, and youre 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 theyll 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 theyll owe the lenders, and decide theyd rather go the equity route, where theyll 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 wont 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.
