By Joe Gutierrez, Lendio Anaheim Funding Manager
As someone who finances start-up businesses (as well as existing businesses), I often get approached by entrepreneurs looking strictly for investors to finance their business; angel investors, private equity, and venture capital funding. I always appreciate entrepreneurs with the courage to dream about investors being as in love with their idea and start-up as they are. There are, however, other options, that are oftentimes more realistic and attainable. It’s important that business owners truly understand the difference between debt and equity financing and what to consider when making this funding decision for their business.
What is equity financing? Equity financing is giving a portion of ownership in your company to someone in exchange for money; the most common form of equity financing is when a company goes public and sells shares of stock to increase their liquid capital (cash). Equity is the right fit for some situations, but private equity financing can be very difficult to obtain and generally you need to be an established business with proof of concept and revenue before you can attract that type of financing. The number I’ve heard quoted time and time again from investors is that fifteen out of every 1,000 pitches they hear will actually receive any type of equity financing; that’s only 1.5%, meaning 98.5% of those looking for equity capital will never receive a penny from an investor.
What is debt financing? Debt is sometimes looked at as a “4 letter word”, but debt is only negative when it’s used improperly and irresponsibly. Debt is simply money that is borrowed and needs to be repaid, generally with interest.
So, why use debt financing? Since there are so many options available for this type of financing, most business owners can find a capital solution that they qualify for and that meets the needs of the business for both its short and long term goals; it’s generally much more applicable to the needs of the average business owner and allows for more freedom with the use of funds and business decisions. Additionally, since there are many types of debt financing, you can utilize multiple solutions simultaneously, which allows for higher dollar amounts and more flexibility to accomplish your goals.
Something else that is vital to consider: although debt financing is money that needs to be repaid, you’re not giving up a piece of your company. I’ve heard so many stories of people giving up a majority share of their company and then feeling like they’re being held hostage in their own business, or that losing control of something they’ve worked so hard to build. I’ve also seen situations where people give up too much equity for too small of an amount of capital, when if they’d taken a loan to start with instead, they could use that capital to grow their business, making it far more valuable, and end up giving less equity for more money.
Before deciding which type of financing is right for you and your company, or taking a loan, it’s always advisable to consult with an expert. Trying to navigate the waters yourself can be not only time consuming and overwhelming, but it’s likely outside of your field of expertise. Just like you go to a doctor to diagnose your illness and write you a prescription, or a mechanic to tune up your car, your business’ funding strategy should be developed and implemented by an expert in business financing. Your financial plan needs to be well thought out with specific use of funds in a strict budget, and you must always ensure you know your return on investment vs. the cost of capital you’re obtaining before accepting any type of funding.