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RESOLVING THE DEBT VERSUS EQUITY FINANCING

Factors To Consider When Choosing Between Debt Financing And Owner Equity Financing

Businesses that are growing require access to sources of business capital. The capital in a company of course comes from the owner or borrowed funds. Generally speaking, business owners prefer to borrow rather than sell equity in the company, as that sale of equity dilutes the ownership position, i.e. they own less of the pie!

New equity can come from friends and family, venture capital firms, and angel investors. These parties are looking for good management, integrity, owner financial stake, and growth potential when they are contemplating equity investing in your company. Debt financing can be short or long term commitment by the company

GROWING BUSINESSES NEED CAPITAL

Businesses that are growing require sources of capital. The capital in a company of course comes from the owner or borrowed funds. Generally speaking, business owners prefer to borrow via debt financing , rather than sell equity in the company, as that sale of equity dilutes the ownership position, i.e. they own less of the pie! New equity can come from friends and family, venture capital firms, and angel investors. These parties are looking for good management, integrity, owner financial stake, and growth potential in a small business / growing business.

However, in the current difficult financial environment, pandemics included! ... many lenders are in fact insisting that business owners put more of their own money into the company. There is never an easy answer when it comes to the debt financing vs equity question.

TAKING ON DEBT IN YOUR BUSINESS COMES AT A COST

When businesses borrow funds there is a cost to that capital - as interest rates on that debt reduces over-all profits. New equity in the company of course does not reduce those earnings, however, the profits are distributed more widely and the earnings are proportionately reduced. The personal credit of owners, as well as their assets / net worth, tends to come to play when considering either debt or equity solutions as well as those interest payments and the desire of lenders to be paid back.

THE RISK OF DEBT LOAD TO A BUSINESS

Borrowing funds of course comes with risk, as those loans must be repaid. Small Business owners sometimes get caught in the trap of financing long term projects with short term money - they are therefore at the mercy of having to always roll over that debt, and potentially also seeing rates go up, sometimes dramatically. Also, a business can carry only so much debt, at which point cash flow becomes a potential problem if the company is over-leveraged.

Currently, rates are very low for businesses that have access to capital. Therefore in many cases, it might make sense to lock into longer-term loans in the current attractive rate environment, and that presents a strong argument to defer equity financing.

YOUR COMPANY MUST PROPERLY PREPARE WHEN APPROACHING A BUSINESS LENDER

When the business owner has made the decision to pursue business loans the old Boy Scout model works very well - BE PREPARED! Small Business owners that do their homework will usually be successful. Let's not forget the banks and finance firms are actually in business to loan funds. Naturally collateral or additional collateral certainly improves the chances of debt financing success and loan approval.

Debt and equity financing as sources of capital should be used for the right reasons - expansion, seasonality of the business, increased inventory and working capital that will increase sales. Funds that need to address business inadequacies such as poor management, financial losses, falling sales, etc. are very difficult to come by!

Solutions for debt capital include :

Real Estate / Asset Leasebacks

Bridge Loans

Term Loans

Government Loans

Unsecured Cash Flow Loans/sub-debt

Additionally, assets can be monetized without the necessary addition of debt; These include:

Receivable Inventory Financing ( or combinations thereof )

Supply chain financing

Royalty finance

Tax Credit Monetization

SUMMARY

In summary, small business owners should carefully consider the positive and negative effects of additional debt financing or equity capital. By the way, financing equity can take a long time and is not a simple financial journey. Which is better debt or equity financing? The answer always lies in the needs of the company as well as the ability to attract either lenders or investors.

Once they have made an informed decision, either on their own or with a credible, experienced and trusted Canadian business advisor at 7 Park Avenue Financial they should consider the cost of that capital and how it is best achieved.