By Jenny Q. Ta, entrepreneur, author and CEO of Sqeeqee.com
Loan financing and equity investment are two common methods of funding a new business start-up, assuming you do not have the capital on your own. Each strategy has advantages. The right choice depends on your short-term and long-term financial goals and personal preferences.
Debt financing is the better choice when you prefer to retain control of your operation, and you do not mind the tradeoff of greater risk for higher earning potential. However, if you would rather share the risk, mitigate debt obligations and bring in top-level experts, invite equity investors.
Ultimately, it will be up to you depending on your own situation. As a seasoned entrepreneur, author and CEO of Sqeeqee.com, the first-of-its-kind social networthing ® site, I have identified the following things to consider when making your decision.
Ongoing Budget Requirements.
When you take on debt, you have to repay it. With debt financing, you restrict future cash flow by tying a portion of ongoing profits to your monthly payments. The amount you put toward debt minimizes reinvestment in growth and earnings distributions to owners.
With equity investment, you do not have to repay the money. Instead, the investors receive a portion of future earnings allocation and potential gains on their shares if the business succeeds.
Financial Risk Distribution.
When you take on debt, you assume the ongoing financial responsibility of making payments. If you default on the loan as a sole proprietor, you sacrifice any collateral property and absorb a major hit to your credit rating. If you set up as a limited liability company, the business suffers the credit damage, but your future earnings are stifled.
A key reason to take on equity investment is to share the financial risk of operating the business. Each investor puts in his money knowing that he may never earn a profit.
If you do not mind the personal risk of debt, you experience more financial gains when the business makes money. Aside from paying your bills, you do not have to distribute profit to others. You retain the profit.
To share the risks, you also have to share the wealth. The more equity investment you use to develop the business, the more diluted your personal earning potential becomes.
A lender does not get involved in the operation of your business. After reviewing your financial situation and issuing the loan, the lender is concerned with getting payments on time.
People who invest money in the company often do not take such a hands-off approach. Large equity investors want formal or informal input in the business. You may have to accept a board member from the investing entity in exchange for the money. If you prefer complete autonomy in company decisions, equity investment is not the right move.
A lender leaves you alone, but you also gain no professional expertise with the funding. Your relationship is 100 percent financial.
If you accept some loss of control to equity investors, you may gain a significant amount of expertise. Some entrepreneurs take on equity investors as much for their expertise, industry knowledge and name credibility as they do for the money. A valuable expert who has money on the line may become a huge asset to the growth of the company.
Jenny Q. Ta is the founder and CEO of Sqeeqee, the first-of-its-kind networthing ® site. Ta is a seasoned entrepreneur with two successful ventures to her credit, and is an author whose book, Wall Street Cinderella, will launch in 2014 detailing her escape from Vietnam during the war and her path to success from welfare to Wall Street.