The essentials of debt and equity financing.
By Marty McGhie
Let’s examine first the advantages and disadvantages of personal equity. The obvious advantage of utilizing your own money to finance business operations or expansion is that you don’t have to pay interest on the money. Additionally, when there is no outside entity such as a bank or a leasing company involved, your assets remain unencumbered from collateral positions, allowing you future flexibility with the use of the value of your assets. As I mentioned earlier, debt financing often will require the personal guarantees of a small business owner. Whether it’s perceived as a blessing or a curse, when you use your own money, in effect, you have already issued a personal guarantee, but at least it isn’t to someone else.
The main disadvantage of personal equity is that you are, in fact, using your own money. If you have the money, whether it’s generated from the business or your own, there is certainly nothing wrong with that. Just make certain that this is the best time and place to use personal money in your business. That question depends on your assessment of personal risk, flexibility, future cash flow considerations both inside and outside of your business, etc. It may be exactly the right thing to do, just make sure you think through all of your options to be sure.
Obtaining investment capital from an outside source-whether it is through venture capital, a stock option plan, a rich uncle, or your own child-changes the rules of business the day it happens. It would be naive to believe that you can bring anyone into an ownership position at your business and assume that things will remain the same. That doesn’t necessarily mean it is a bad thing; adding additional partners into the management of your business may be just what you need.
Here, however, are some points to consider: Just as is the case with personal equity, outside equity avoids interest costs and the additional issues with debt financing. You may be in a situation that requires an amount of capital infusion beyond your personal capabilities. Partnering with an additional investor can be a solution to that problem. If you are in high growth mode and want to leverage that growth faster than your business operating capital or your personal equity will allow, using outside money is a great way to make that happen.
By far, the most challenging aspect of using outside money is that you lose some amount of ownership of your business. It may be a minority or a majority position, depending upon the amount of capital the outside investors put into your business, but you’ll now have new business partners. The reality of outside investment money is that virtually everyone putting their money into a business wants to have some say in the management decisions, and it’s usually more than you think. If a significant amount of capital is involved, it’s likely that the investors may even want a controlling position in stock ownership. The point is, if you choose this route to infuse capital into your business, go into the deal with your eyes wide open. For better or for worse, it will be different from that day on.
Of course, these are just a few of the basic options when it comes to obtaining capital for your business. If you’re serious about securing additional financing for the expansion of your business, be sure to examine all the possibilities available, consult your professional help, and determine which situation will work the best for you. Careful planning is the key to structuring a deal that will help your business grow to the level you desire.
Marty McGhie (firstname.lastname@example.org) is VP finance/operations of Ferrari Color, a digital-imaging center with Salt Lake City, San Francisco, and Sacramento locations.