Debts vs Equity
Debt vs Equity
Debt vs Equity
Both can fund your business
But each mean something completely different from the other
Let’s start with some definitions…
What does it mean to raise Debt?
Raising debt means you received money with the expectation that you will pay back the amount, almost often with interest
It is a liability (since it’s something you owe to a creditor)
and is CAPPED…that is, there is an exact amount that you owe
What does it mean to raise Equity?
Raising equity is when you receive money, but this time in exchange for ownership in your company
This means that you have a type of liability to the new owner, but this time it’s UNCAPPED…as it involves giving a share of the profit & loss / sale of the company away
This would show up in the Owner’s Equity section of your balance sheet
What are the Pros & Cons of raising debt?
Raising debt can be a great way to inject capital into your business if you are comfortable with repaying the amounts with interest
Business owners who are bullish on the future of their business may have no problem raising debt, since they feel confident they will be able to use that capital to generate an even stronger return than what they will pay in interest
The cost of the interest + the schedule in which you agree to repay the loan however may catch up with you, leaving you in a difficult position if things don’t go as planned
What are the Pros and Cons of raising equity?
Raising equity can often times be a great way to raise capital without having to repay the amounts…let alone the lack of interest payments
Often times an equity owner will also be a proud contributor to the management of the company, yielding the company both with capital as well as expertise
It can come at a steep cost however, as you no longer have as big of a pie to share in the profits
Equity owners may also get voting rights, ultimately controlling the direction of the company, which can cause problems if you are not aligned
When should you raise debt, and when should you raise equity?
While every business is subjective, my 2 cents are:
Raise debt when you feel confident that you have a proven formula for generating a large ROI with the capital, and the interest is low
Raise equity when you feel there is a fair valuation for the company, and you are aligned with the person who wants to become an equity holder in your business
Those are my thoughts on raising Debt vs Equity.