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Financing 101 for Entrepreneurs - Debt vs. Equity or Both?

Written by: Ellisa Brenneman

Article Overview: Small business owners can choose from two basic types of financing- debt and equity. There are advantages and disadvantages of each type that may be used for different purposes.

Financing 101 for Entrepreneurs - Debt vs. Equity or Both?

Small business owners can choose from two basic types of financing- debt and equity. There are advantages and disadvantages of each type that may be used for different purposes.

Before you seek start-up capital, organize your records as follows;

• Gather you're financial business records including tax returns
• Speak with business partners or family members about the sometimes uncomfortable option of giving up partial control of the business to potential investors
• Request copies of your personal and any business credit reports

Entrepreneurs who seek financing face a fundamental choice: Should they borrow funds or take in new investment capital? Since debt and equity are accounted for differently, each has a different impact on earnings, cash flow, and taxes. Each also has a different effect on leverage, dilution, and a host of other metrics by which businesses are measured. The planned use of funds will also affect the choice of financing, with one option more appropriate for certain uses than the other.

Debt can be a loan, line of credit, bond, or even an IOU -- any promise to repay borrowed amounts over a certain time with a specified interest rate and other terms. Debt is accounted for as a liability of the company, and interest payments are deductible business expenses. In the event of bankruptcy or insolvency, debt holders take priority over equity holders.

For a small business, debt financing has both advantages and disadvantages. On the plus side, debt can be relatively simple to secure through a bank or other financial institution and is available with a broad range of terms, allowing you to customize the debt to meet your specific needs. And since most debt entails regularly scheduled payments of interest and often principal as well, debt is easy to plan around. Perhaps most important, debt, unlike equity, will not dilute your ownership interest in your company.

On the minus side, however, financing with debt can be more expensive, and you will have to meet scheduled interest and principal payments regardless of your cash flow. Although loan terms can be negotiated to build in flexibility, ultimately the money must be paid back.

Debt is most often used to fund a specific project or initiative that has an identifiable implementation time frame. It's also used as a cash flow backup in the form of a revolving line of credit. To attract lenders, you will need to have a good personal and business credit history, sufficient cash flow to repay the loan, and/or sufficient collateral to offer as a second source of loan repayment.

Equity differs from debt in that it represents a permanent ownership stake in the company. When you finance with equity, you are giving up a portion of your ownership interest in -- and control of -- the company in exchange for cash. Equity investors may demand dividends or a portion of annual profits. But most investors in small businesses seek long-term capital gains on their investment, meaning that at some point these investors may look to opt out. This can mean the eventual sale of the business or the need to bring in replacement investors in the future.

The most common sources of equity financing for start-up entrepreneurs are personal savings or contributions from family, friends, and business associates. Many successful entrepreneurs find start-up money, grants and loans using all inclusive support centers such asEthos Mentor,Business Finance.comor the Small Business Association (SBA).

Venture or seed capital companies can also be sources of new capital, although they generally deal in larger financings. If your business is incorporated, anyone contributing equity capital would receive shares in the business. If it is a sole proprietorship or a partnership, they would receive an ownership share of the business.

While equity financing can be used for many different purposes, it is usually used for long-term general funding and not tied to specific projects or time frames. The major disadvantage to equity financing is the dilution of your ownership interest and the possible loss of control. Moreover, equity investors in smaller businesses generally look for high returns over time to compensate for the risk.

In practice, most businesses use a combination of debt and equity financing. The concern is getting the right balance. If you have too much debt, you may overextend your ability to service the debt and can be vulnerable to business downturns and changes in interest rates. On the other hand, too much equity dilutes your ownership interest and can expose you to outside control. For more information visitEthos Mentor.

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Related Forum Posts
Getting something for nothing? - This is a tough one because it's hard to get something for nothing. There are two forms of financing - equity and debt. Equity is when you give up a part of your company / invention / idea in return for money or services. Hopefully the person you are bringing on is someone you can work with because you are now partnered until you sell or close down the company or buy each other out. Debt is when you borrow money so you aren't giving up a piece of your company but you have to pay the money that you are borrowing back. If you have a solid credit history or tangible assets then you can get it from the bank. If you don't have either then you can get private money but the interest rates will be higher (10% or more). Since every month you'll have to make payments you'll have to think about how long it will take you to start bringing money into your business from your invention. Either way you're giving up something in return for the financial help.The only other options I can think of are government grants that you don't have to pay back or befriending people who want to help you because they like you and by doing so they are being rewarded (very hard to find!) Good luck!
Lisa Shepherd Story - Great story! I love the Earn - Learn - Equity - it's very relavent for new entrepreneurs.
Home Equity to Finance your business - Jen, do you have Home Equity you can leverage? Maybe a relative or close family member can do it for you in return for an interest "balloon payment" at the end of 5 years (the rate would be above what they would get if they invested it in a GIC).
Re: Quick Ways To Utilize SEO Effectively - 1. If you dont want too much competition from other SEO's, choose your keywords precisely.For example, Instead of keyword Loan choose keywords like Bank Loan, Equity Loan, Student Loan, Home Loan etc. Order of keyword also matter for search engines. Search engine treats ?Loan Equity? and ?Equity Loan? as different keywords. 2. Best seo practice is to get at least one of your primary keywords in domain or sub domain name of your website. You can use hyphens (-) to separate multiple keywords. For example: seo-service, seo-guidelines, free-seo each cover two keywords. 3. Get your second or third keywords in your directory name and filename. 4. Keep your webpage free from any syntax error, declare document type at the beginning and validate your HTML and CSS because search engine don?t like pages with too many errors. 5. Give a short Title in of your page in 3-9 words (60-80 characters) maximum in length containing your primary keyword. Remember it will be displayed in search results so choose wisely. 6. Try to include your most important keyword phrases in heading tags on your page if you can but keep in mind it should not be exactly same as title of your page. You can use (H1 H2 H3) tag for specifying anything important. To reduce size of heading use CSS. 7. Specify Meta keywords in heading of document. Limit it to 15 to 20 words. Although not all the search engines give importance but there is no harm doing it. Search engine like Yahoo still give it importance. 8. Write Your Meta Description tag attractive containing keywords because it will appear on the search engine result pages. 9. Use text for navigation menu instead of using images or Java scripts. 10. Try to include your most important keyword in hyper linked text and text and text that immediately precedes or follows the hyperlink. Do not use same keyword always use synonyms at few places. Just like instead of seo, I have use search engine optimization at many places on this page.
CEOs and Email - Slaves? - I wonder if the emails they are responding to are filtered thru their assistants first 'cos they seem to spend a lot of their off hours responding to them. True they are successful but I'm not sure I'd be willing to pay that price. I'd be interested to know what's the in the typical day planner of Entrepreneurs on the Forum. Entrepreneurs are a different breed than Paid Employees- so it would be interesting to view the contrast.


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