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Is it best to take on debt financing or equity financing in an unstable economy?
I haven't talked with a bank yet, but with current economic times being low right now. What's the best way to go about financing a new business idea? Would we see any significant differences down the road between the two?
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3 Answers
The answer has a little less to do with the current economic climate than it does with what you are trying to do within the framework of your business model. What is happening in the economy only means you need a stronger position when going after these types of capital.
Equity Investment means that you are willing to sell part of your idea to bring in capital to help build the company. Today that will mean; how good is the team? have they ever raised capital before? what will the capital be used for to build shareholder value? what is the exit plan? These questions must be answered in a bullet proof fashion, meaning no holes in the story.
Debt Financing is collateral based, relatively easier to obtain, ultimately less expensive to the entrepreneur, and doesn't have partnership strings attached. But it relies on liquid collateral such as; real estate, revenue (in the form of account receivables), or equipment. These forms of collateral can be quickly turned back into capital in case of a default, so their value can be borrowed against. In most cases, but not all, you need to have a company that is already making sales, has a fairly good track record both personally and with the business.
Both of these methods need to be thought out and have a solid strategy regarding obtaining and using the capital.
I would like to echo what Gary Honig states in terms of the differences between the types of financing available to businesses. However, depending on the industry or specific activities in which the business engages, different financing strategies may make sense. For example, Green Energy companies dealing with tax-exempt entities might well benefit from equity financing where the investor is able to utilize federal energy tax credits that the tax-exempt entity is not, thus reducing the investors equity stake.
This is but one example of many special cases. I would encourage any of you with such questions to contact me at IFS Capital (888-766-1924) to discuss your options. In addition, we have the capability to reach out to our network of Lending Partners and presenting them with your company's financial data to obtain equity and or debt financing terms that best suit your needs.
Regards,
Jim
Carroll,
I got a line of credit for my business (in development mode; no revenues) fairly quickly & easily in October 2008. In March 2009, I went back for another 25k (I'd told them I needed 50k total, so no surprise) and it was much tougher to qualify - I needed a very strong co-signor to make the loan, and there were additional legal costs as well.
While credit is technically cheaper (especially right now) tight policies may rule this out for you, depending on the collateral you have available (as Gary discussed). Equity has the benefit of not requiring repayment, but remember that you then are dealing with shareholders - one CEO I know spends most of his day trying to mediate shareholder disputes! That said, I'm very fortunate that my co-investors are like-minded folks who bring far more to the business than just equity. I really couldn't do it without them.
Long term, you should be able to pay out your loan, and then everything you've built is yours. Alternately, if you bring on investors now, they'll probably be with you well into the future.
So, my recommendation would be:
1) If you can handle the interest expense for at least the next 3 years, go with debt financing IF YOU QUALIFY.
2) If you don't qualify, find equity partners that think as you do. You're going to be in bed with them for a while; best make sure it's comfy. Also, make sure they can provide support/guidance/management in an area you are weak in. In my company, my strength is as a subject expert; so, I've brought on a very senior sales person with impeccable credentials to handle sales and the CEO role, and a developer with scads of experience. It took a lot of time to assemble this team, though...
3) Given the difficulty of raising funds, consider your ability to bootstrap (self-fund) for the foreseeable future. Plan out how long it will be until you start to make money, then double that time frame. That's how long you need to keep things afloat BEFORE you quit your day job.
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