Is it Better to Borrow or Give Up Equity—and How to Decide
Is it better to borrow or give up equity when searching for ways to grow your business? When looking into debt or equity financing there’s no automatic right choice, as one company’s capital needs are different from another. To raise capital, we think it’s critical to determine where you can get funds and how to evaluate what you’re going to do with the capital, once acquired.
By understanding your options, and their pros and cons, you’ll be in a better position to make informed decisions regarding how to proceed in choosing to issue equity versus adding debt.
Four sources of capital
In addition to issuing equity or going to a debt provider, capital can be obtained two other ways: cash flow raised from existing operations, or by selling off company assets, assuming your company has assets it can sell.
Choosing between issuing equity versus debt
Oftentimes it may be more feasible to take on debt when looking at what the potential return on equity is. Is it worth dividing up pieces of your business to grow? Consider this: if you own 100 percent of your business, and you choose to bring in partners and sell shares, what is the likely return for you as the existing shareholder based on your plan of action in using your new capital? Is it worth issuing equity instead of taking on debt?
An evaluation has to occur as to whether you and your existing shareholders will grow the value of their shares by taking on additional shareholders. For example, if your business were represented as a pie, if you split up the pie, it’ll need to get bigger, and at what rate the pie increases in size is a critical factor when choosing debt or equity financing.
Final judgement: Debt capital versus equity capital
Debt capital, which is what you raise when borrowing funds from a bank or other institution, will need to be repaid at a future date. Standard debt financing often comes by taking out loans or through credit.
A bonus in choosing debt instead of equity financing is that it typically allows businesses to grow more rapidly and there’s no need to take on additional shareholders. Also it’s important to note that repayments on borrowed money are often tax-deductible. The downside, of course, is the amount borrowed will need to be repaid with interest, regardless of how your company has performed. A lack of revenue can make debt, instead of equity, financing a dicey proposition.
The key benefit in issuing equity instead of choosing debt is you’re not repaying that money, as the funds are acquired through the sale of stock. What this means, however, is that your business is then tethered to those new shareholders and the need to generate profits for them in order to return their investment, and keep a healthy valuation of your business which will be expected to pay dividends. When choosing debt or equity financing, equity may seem like the more attractive option because money won’t need to be repaid, but it’s good to keep in mind equity financing is a greater risk to investors than debt financing is to a lendor, which means equity often ends up costing more than debt.
By partnering with AmpliFi, you’ll have access to our core solutions, which are available à la carte to help meet the specific needs of your business, or as part of our premier Business Capital Management package, which consists of five centers of excellence: financial planning and analysis, performance management, strategy management, corporate finance and analytics. Contact the AmpliFi team today to discuss debt or equity financing, and your other business needs!