Every entrepreneur aspires to take an idea or skillset and transform it into a highly profitable, successful business. Sometimes using external capital is necessary to achieve this goal. Although bootstrapping (i.e., using your own funds) to finance the business can work for some, many require external capital to unleash the business’ true potential.
External capital can come in two forms: Debt or Equity. There are also hybrids of the two (a topic for another blog!). Having a strong understanding of these types of capital is important, as there are advantages and disadvantages for each. Both are important financial tools that can provide advantages to help your company grow.
Below is a summary of the key features for debt and equity capital. Although the table is not an exhaustive list of features, it is important to assess the fit of any capital source to your business.
|
Debt Capital |
Equity Capital |
| Ownership |
Debt financing is non-dilutive. |
Equity investors provide capital in return for a portion of the company’s ownership. The existing shareholder’s percentage of ownership thereby gets diluted. |
| Control |
Lenders typically do not take a board seat or exert influence on how the company is operated. |
Equity investors often require a board seat and will have influence on the strategic direction of your company. |
| Cost |
Generally, debt capital is cheaper than equity financing. Cost will vary based on the type of debt and is commonly repaid via a payment of principal + interest. |
Since equity holders have the last claim to a company’s assets, it is more expensive than debt financing. Higher risk requires higher reward. |
| Tax |
Interest on debt incurred is tax deductible and can reduce your company’s tax obligation. |
There is no taxable benefit for receiving equity financing. |
| Repayments/Obligations |
Debt financing requires regular repayments based on a fixed schedule and may have certain covenants that you must meet (i.e., minimum debt to equity ratio). As a business you are under legal obligation to repay the debt, which requires you to always have sufficient cashflow. This can hinder any additional side projects or investments. |
An equity injection strengthens the company’s balance sheet and in theory should improve your company’s cashflow, allowing you to focus on scaling and growing the business. |
| Time |
Process to receive debt is often faster and requires less diligence than equity financing. |
Due to the risk involved, equity investors perform stringent and timely due diligence, which can often take months to close. |
| Strategy |
So long as a borrower is not in breach of covenants, they are free to operate their business as they see fit. |
Often an equity investor is sought because of their expertise which can help guide the company in its growth objectives. An equity injection can be part “cash” but more often than not, it’s a valued partnership to accelerate the Company’s strategy. |
| Reporting |
Typically require quarterly reporting with more in-depth reports provided on an annual basis. |
Typically want monthly reports so they can closely monitor investments. |
For additional insights on debt vs equity and the pros and cons for each please contact, Muaz Elharram at melharram@welchcapitalpartners.com.
Every entrepreneur aspires to take an idea or skillset and transform it into a highly profitable, successful business. Sometimes using external capital is necessary to achieve this goal. Although bootstrapping (i.e., using your own funds) to finance the business can work for some, many require external capital to unleash the business’ true potential.
External capital can come in two forms: Debt or Equity. There are also hybrids of the two (a topic for another blog!). Having a strong understanding of these types of capital is important, as there are advantages and disadvantages for each. Both are important financial tools that can provide advantages to help your company grow.
Below is a summary of the key features for debt and equity capital. Although the table is not an exhaustive list of features, it is important to assess the fit of any capital source to your business.
|
Debt Capital |
Equity Capital |
| Ownership |
Debt financing is non-dilutive. |
Equity investors provide capital in return for a portion of the company’s ownership. The existing shareholder’s percentage of ownership thereby gets diluted. |
| Control |
Lenders typically do not take a board seat or exert influence on how the company is operated. |
Equity investors often require a board seat and will have influence on the strategic direction of your company. |
| Cost |
Generally, debt capital is cheaper than equity financing. Cost will vary based on the type of debt and is commonly repaid via a payment of principal + interest. |
Since equity holders have the last claim to a company’s assets, it is more expensive than debt financing. Higher risk requires higher reward. |
| Tax |
Interest on debt incurred is tax deductible and can reduce your company’s tax obligation. |
There is no taxable benefit for receiving equity financing. |
| Repayments/Obligations |
Debt financing requires regular repayments based on a fixed schedule and may have certain covenants that you must meet (i.e., minimum debt to equity ratio). As a business you are under legal obligation to repay the debt, which requires you to always have sufficient cashflow. This can hinder any additional side projects or investments. |
An equity injection strengthens the company’s balance sheet and in theory should improve your company’s cashflow, allowing you to focus on scaling and growing the business. |
| Time |
Process to receive debt is often faster and requires less diligence than equity financing. |
Due to the risk involved, equity investors perform stringent and timely due diligence, which can often take months to close. |
| Strategy |
So long as a borrower is not in breach of covenants, they are free to operate their business as they see fit. |
Often an equity investor is sought because of their expertise which can help guide the company in its growth objectives. An equity injection can be part “cash” but more often than not, it’s a valued partnership to accelerate the Company’s strategy. |
| Reporting |
Typically require quarterly reporting with more in-depth reports provided on an annual basis. |
Typically want monthly reports so they can closely monitor investments. |
For additional insights on debt vs equity and the pros and cons for each please contact, Muaz Elharram at melharram@welchcapitalpartners.com.
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