Debt or Equity – Which is Better?
Which is better?
You may be thinking that a loan is much better than an equity injection because you are not giving up an ownership interest in the business – potentially forever. Yes, but loans are difficult to get. Most banks won’t even consider a startup business loan. Banks seek security – something of value that they can repossess if you don’t make the loan payments. Bank loans for a business, especially startups are really a long shot for most. Banks are uneasy with businesses that have no history, no experience, limited reserve funds and inadequate collateral to back the loans. Thus, taking on business investors may not be your preferred solution, but it may be the only option you have!
Equity partners may be more valuable than you think. They can often bring in additional contacts, resources and management experience. They offer the entrepreneur a good sounding board to brainstorm new ideas and business processes. And yes, your investors are probably the most likely place for the business to raise additional money for expansion and modernization.
In the end you probably should consider both – debt and equity as equal candidates – using each in a proportion that makes good cash flow sense. Land and buildings have good collateral value and the going interest rates are low. These are good projects to borrow money for. The money for large pieces of equipment, trucks, service vehicles and even some inventory may be borrowed. It is usually much better to structure a repayment schedule and borrow the money than to expend available cash.
In most cases it’s difficult to borrow money for operations. Lenders shy away from borrowers that want to use funds to pay the entrepreneur’s living expenses, pay off credit cards, or to purchase vehicles that are more often used for the family business rather than actual work. Money spent on rent, utilities and payroll is gone each month and a new obligation is right around the corner. These are expenses that the lenders expect to be paid out of normal sales.