How To Capitalize Your Business
By Andres Fernandez
February 22, 2021
How To Capitalize Your Business
By Andres Fernandez
February 22, 2021
For small and medium-sized business owners looking to scale, working capital is king. To capitalize your business there is equity and debt. When starting a business, or when operating the business, owners need to determine how to balance these two options. There are advantages and disadvantages as to both, and this article will discuss those in detail below.
What is Capitalize?
Capitalize is to record a cost or expense on the balance sheet for the purposes of delaying full recognition of the expense. A business can be capitalized with either debt or equity, which taking out a loan has never been easier in 2021.
What is Equity?
Equity is a percentage of ownership within a company. In the case of a corporation, equity is issued in the form of shares, or stock. So in the case of a partnership, equity is issued in the form of partnership interests. And in the case of an LLC, it is issued in the form of interests.
Equity financing involves selling a portion of a company’s equity in return for capital. Yes, exactly how you see it on shark tank! For example, the owner of ABC might need to raise capital to fund a business expansion. The owner decides to give up 10% of ownership in the company and sell it to an investor in return for capital. This could potentially hurt or help you to capitalize your business.
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What is Debt?
Debt is a loan issued to the company. The document that evidences the debt is a promissory note, which explains the terms of the loan, such as when the loan will be repaid and at what rate the interest must be paid. As opposed to equity, lenders receive no ownership interest in the business. But there are exceptions, such as convertible notes, which are essentially debt that can later be converted to equity. These are common in more complicated financings, such as angel investor and venture capital financing.
For the rest of this article we will be showcasing the advantages and disadvantages as to equity and debt financings, respectively, from the perspective of the business owner.
The Advantages of Equity
- There will be no need to pay back any money, including interest on it. This is due to the fact that the business can benefit from outsourced capital in return issuing ownership or equity to the investors. Whether the business ends up making less than expected on the investment, depending on the contract, most cases you will not have to repay the investors.
- If you lack creditworthiness because of poor credit history or lack of a financial track record – equity can be preferable or more suitable than debt financing.
- A great advantage to capitalize your business in equity financing is that you might form some sort of professional relationship with your partners. Which gives you the opportunity to learn about the knowledge they provide and the experience they have achieved. Some might be well-connected, allowing your business to potentially benefit from their knowledge and their business network.
- And without debt, there more working capital available for the business to capitalize.
The Disadvantages of Equity
- Downside for equity financing is quite large. In order to gain funding, you will have to give the investor a percentage of your company. Having to share profits and consulting with your new partners any time you make decisions affecting the company.
- There will also be loss of control or power. The price to pay for equity financing and all of its potential advantages is that you need to share control of the company. This also depends on the contract and percentage of every investor.
- In some cases, the equity may be considered a security and federal and state securities laws will have to be compiled with. This means that a lot of paperwork will have to be completed, and many other legal requirements will have to be met. (Basically, it can get really expensive really fast.)
The Advantages of Debt
Debt finance is borrowed money that you pay back with interest with an agreed time frame. My best guess is that many of your business owners already have an idea or have taken out a loan for any reasons regarding your business. The most common forms of debt financing includes bank loans (they take forever to get your money and paperwork galore), lines of credit for the business, and equipment financing.
- Maintaining Ownership – debt financing allows you to have complete control of your business, including financial decisions or decisions that can affect the company.
- Tax Deductions – unlike private loans, interest fees and charges on a business loan are tax deductible. This is a big incentive for debt financing
- Retaining Profits – to capitalize your business through debt financing your only obligation to your lender if making repayments within agreed time frames. In addition, you do not have to share your business profits.
The Disadvantages of Debt
- Lack of access can be difficult to find secure debt finance. Banks tend to be conservative when lending money. Online business loans has quickly moved up in the industry of lending right beside the banking institutions.
- You need to be positive your business can generate revenue to service the debt. Even if your business fails, the loan needs to be repaid, whether its to the bank or a lender.
- Your credit score could affect the amount and terms of securing a loan.
- If the lender required collateral on the loan position taken out, then the collateral will be lost if the loan is not paid back.
To Finish Off
Many small businesses tend to use a mixture of both, debt and equity financing. Reaping the benefits of both types of financing will being careful not to thinly capitalize your business. If you’re looking for a debt financing loan for your business, make sure to reach out to us and we’ll get you funded within 24-48 hours. Or just quickly fill out our 4 step application.
