Raising Capital through Debt & Equity
Business financing comes in two types, lending and investing. Either or both are the principal means of obtaining the capital to begin or grow your business. Which is the best approach to take depends on many factors unique to your situation. What follows in an examination of the advantages and drawbacks of each.
Borrowing money from an outside source is a more straightforward means of coming up with cash. The U.S. Small Business Administration can serve as guarantor for many types of small business loans which usually have longer terms and lower interests than typical bank loans.
In general, using debt can mean obtaining the funds for almost any kind or size of business, and the options for debt financing include other means than a bank loan. A considerable advantage of debt financing over equity is that lenders unlike investors have no say in how your business is run.
Like any debt, loans will have to be repaid at some point and with interest. Many business owners favor investing money in your own business each month rather than repaying a loan. Loans will also require a payment each month, even if your sales have been poor.
What about equity financing?
Obtaining capital through equity investment is quite different. Unlike taking out a loan, equity financing allows you to raise capital by having investors put capital into your business, thereby becoming part-owners of the business. These investors, in turn, are entitled to a share of the profits over time, usually three to five years.
A key difference is that while you can approach your family and friends to invest in your business, unlike a loan, investors are often not able to be repaid for several years once your business has started to become profitable. After a business takes off, it may attract the attention of angel investors or venture capitalists which can input much large sums of money.
Equity thus eliminates two of the drawbacks to debt financing: the constraints on available cash flow and the risks associated with personally backing a loan. Equity also allows more time to grow your business before investors need to be repaid. .
On the other hand, owners need to realize that they are effectively giving away part of their company to the direction of investors, and should any owns more than 49% stake in the company can assume control. This can create obstacles for business owners who are looking for loans since some lenders can require anyone with at least a 20% ownership to also sign for the loan.
Determining what kind of financing your business will need depends on many factors including what type of business you own. It is critically important you consult with a highly-skilled Houston business lawyer before you make any major decisions so you take the right steps for your business.