Debt is often thought of as a four-letter word. But used in the right situations and it can actually be your friend. One of those situations is when you’ve had a great business idea, and you need some capital to get it up and running
Note that the operative word here is “great.” All too often entrepreneurs will get carried away with their products, thinking that they’re amazing when they’re not what the market wants. They come up with something which they think is cool from a technical perspective but doesn’t really have the market applicability they expect. They end up borrowing money to retool their facilities and take on new staff, only to find out that demand never materializes.
So how do you know when to go into debt? It’s a problem that harangues the CFOs from the biggest companies in the world. In fact, it’s such a difficult problem to solve that some top execs get paid millions of dollars a year for the privilege of trying.
Debt Versus Equity
When it comes to raising capital, there’s an age-old debate of whether to choose debt or equity. Most companies adopt a combination of both during their growth stages, but the costs of giving up ownership are arguably greater than those of incurring debt.
The reasons for this are relatively straightforward to understand. When you take on debt, you essentially owe the lender a fixed amount of money (unless of course, you repay late). If you’re legally a business entity, your interest payments are tax deductible. And finally, you don’t actually have to cede any control of the firm to a third-party investor. Once the debt is repaid, you retain your 100 percent ownership.
Equity, on the other hand, imposes far more severe long-term costs on your business. Let’s say that you need to borrow $100,000 to start up your business. If you offer that value in the form of a share of your firm, you’ll owe investors a share of the profit every time you make money. Worse still, even if you pay back ten times what was initially invested in your company, that money still flows to shareholders – not your personal bank account.
When Is Equity Better Than Debt?
Given the proliferation of sites like personalloan.co, it’s now easier than ever to get good deals on loans, even for people setting up speculative businesses. This helps open up capital markets to more people than ever before, ensuring that people can secure money when they need it.
But the argument has been made traditionally that some types of businesses are better financed through equity than loans. These include the capital-intensive industries in manufacturing, resource extraction, and airlines, according to time.com. But while some entrepreneurs, like Elon Musk, do try to start up these types of firms, the vast majority of new businesses require only very little capital expenditure. And this is ultimately why outright loans, rather than shares, are the best way to fund these sorts of ventures.