So, your business is growing, is it? And you needed money yesterday to buy more trucks, more space, hire more people, have more cash on hand, or put out miscellaneous fires?
As the saying goes, money doesn’t grow on trees. So, let’s talk about what type of money – aka “capital” – may be the best for you and your business.
In small business, the default answer is typically a loan from the bank or credit union. And often that is the right – or only available – answer. But if you want to excel in business, for an important decision like this deeper consideration is worthwhile before you automatically run down to the bank and start submitting paperwork.
Equity or Debt
First, you should consider if a loan (debt) is the right type of capital for your business, and a good fit with your business, preferences, and goals.
There are basically two main types of capital. Equity and Debt.
Equity is a permanent form of capital that comes from an investor and benefits them with a share of profits and ownership of your business. Debt is a temporary form of capital that comes from a lender and benefits them with regular periodic principal and interest payments.
Ownership or Obligation
When distinguishing between the two primary capital types, think about equity as ownership or a share in the gains of success and losses of failure. Think about debt as obligation that you and your business are bound to pay back. And consider which you’d prefer to give away or take on.
Which Type Fits Your Business
To establish and maintain control of your business, self-funded capital is necessary. Self-funded capital is money either made available from the personal savings of the owner(s) (i.e. you) or from business profit reinvestment. Most small businesses are started and sustained with at least a significant chunk of this capital type.
If that type of capital is not available or in short supply, then consider: do you want a financial partner in business who will share in both the ups and downs, and could your business benefit from such a relationship – i.e. 1 + 1 = 3? Someone who will share in the success if you do well, but to whom you may owe little or nothing if you do not?
If you answered yes, equity investment might be the capital type to choose for your business. Generally, small businesses obtain this type of capital from friends and family or through so-called “Angel Investors.” http://www.investopedia.com/terms/a/angelinvestor.asp
Or would you rather have a fixed obligation to a lender that stays the same no matter whether you succeed or fail – and an obligation you’d effectively “pay off” with business assets if your business struggles or fails?
If you answered yes, debt might be the capital type to choose. Typically, this comes from banks and credit unions, but can sometimes also come from individuals.
Count the Costs
Since equity investors typically share in the profits as your business grows and the proceeds upon a sale, equity capital can be most costly if your business succeeds and least costly if it fails.
By contrast, debt typically carries the same cost regardless of performance, including if your business assets are taken if you are unable to pay your obligation in cash. This particular feature of debt capital can be troublesome if your business hits a rough patch, wants to continue operating independently, but cannot meet its debt payment obligations. Most especially, this is a major risk of debt for businesses that experience cyclical or seasonal dips in activity.
Don’t Paint Over Rust Spots
Whichever capital type or types best fit your business, you should also consider why you need capital at all. Here’s why…
Like painting over a rust spot, bringing in debt or equity capital sometimes only (temporarily) covers over significant business problems… like poor pricing/estimating… too little profit… growth that is too rapid... little or no long-term strategic planning... too much owner distribution and not enough business reinvestment…
The good news is that all of these common problems have solutions, as we regularly address here in blog posts and in depth in all of our services. But if you don’t specifically identify and correct problem areas, they will continue to corrode your business – like a painted-over rust spot!
So do what you would do if you were restoring your favorite classic car… get rid of all “rust spots” first before you paint over anything with debt or equity investment capital. If you haven’t ever looked for your business’ “rust spots,” we have a handy tool for download here to help you.
You can set yourself up with a sweet ride – for a long time – if you do!
Added Closing Thought:
Do you wish you were out of debt?
If you and your business are indebted, are you ok with debt and how much of it do you have? This matters to this discussion because business growth and debt growth are often inter-related. In particular, the more a business with hidden “rust spots” grows, the deeper its owner can get into troublesome debt.
As for me… my bias is oriented toward rust-free business models that generate profits efficiently enough that they do not require external debt or equity capital. This is in large part because, as an owner myself, I prefer operating free of the stress and negative external influences indebtedness can bring.
If you’re like me and would prefer to be debt free, we’ve got a great tool to help you establish a specific plan to get there. It will help you set a specific payment plan that will enable you to become debt free within any number of years you choose.
You can find and download it from our Tools page, and I invite you to check it out right now here!
Long live small business!
Long live small business owners!
Jim Smith, Founder