Capital is the lifeblood of companies. Sooner or later, every founder would have to grapple with how to raise the money needed to sustain growth or expansion. Broadly speaking, there are two main options: debt or equity.
While debt involves borrowing money that will be repaid at a later date with interest, equity is more about giving a stake to investors for the money you receive from them. Unfortunately, the financing world is filled with so many misconceptions that make it difficult for founders to make the right choice. That’s why we’re going to explore some of those myths.
Myths About Equity Financing
If you have a limited idea of equity financing, you can check out our blog post on that subject. Here are some of the most common myths about private equity investors.
#1 Equity investors take advantage of business owners
By its very construct, private equity is not supposed to be a win for the investor and a loss for the business owner. Contrary to that, the only palatable outcome for investors is a win/win scenario. Why? By investing in your company, investors can ONLY make a return if the company eventually becomes successful. If the business tanks, they lose all their investments and you do not owe them one dime.
However, investors can sometimes put undue pressure because they’re motivated by profits. But as long as you retain majority ownership in your company, you’ll always have the control to make important strategic decisions.
#2 Equity investors are only good for their money
Again, this is not true. Savvy investors tend to invest in industries that they have a good understanding of. This means that asides from their capital, they come with a vast wealth of experience that can be invaluable to the business owner.
Moreover, investors also have a robust network of key industry contacts which they can harness to help you advance and develop strategic partnerships. That’s why it’s very important that when you’re seeking equity financing, you opt for investors that bring more than just their monetary investments.
#3 Once the equity investor is ready to exit, you MUST sell the company.
Equity investors are not giving you capital because they like your face. Instead, they believe your business can make them money in a few years. Typically, startup investors want to exit within the next five to eight years.
Common exit strategies include acquisitions, IPOs, mergers & acquisitions, among many others. However, business owners are not forced to sell the company or take it public, especially if you have a majority stake in the company. However, do not expect to hold their investments forever. Having options for exiting even before you receive equity financing is prudent.
Myths About Debt Financing
If you want to learn more about debt financing, you can check out our blog post here. But for now, let’s examine some of the common myths when it comes to debt financing.
#1 Banks are the best place to get a loan
When you think of taking out a loan, the first picture that probably comes to mind is the bank. You already have a good relationship with your bank so sure enough, they should be able to lend you a few thousand dollars. More often than not, that is not the case. Banks are very choosy in whom they lend to and they try to get the best possible interest rate. Little wonder, they contribute a meager 23% of all loans raised by small businesses.
There are many other sources of loans – many of which you can get at more competitive rates and promptly, with reduced paperwork.
Some examples include:
- Enterprise guarantee loans
- Merchant cash advances
- Invoice discounting
- Lines of credits
- Term loans… and more.
#2 Debt kills startups
Did you know that about three-quarters of small businesses take out small business loans, credit cards, and lines of credit? Sometimes, taking out a loan might even be the best course of action, especially if the amount you need is small, like say $10,000.
True, not all debts are good. That’s why you have to ensure that you carefully analyze the terms of the debt – interest rate, payback period, and other relevant metrics – to make sure that it isn’t predatory. Similarly, you should assess your ability to make the required monthly payments before you opt for debt. When used wisely, loans can be a great way to raise the capital you need to expand your small business.
#3 Equity is better than debt
Given the glamour of tech startups, equity has a more ‘sexy’ feel to it than debt or loan. However, whether you opt for equity or debt should be determined by your specific case. Equity and debt have their advantages and drawbacks so it’s key to know them before making a choice.
The biggest plus for equity financing is that you get to secure zero risks for the money you receive. However, you lose some stake in your company to investors.
On the other hand, if you take out a loan, you get to retain absolute control of your company. However, you incur higher risk as you’re obligated to pay back investors whether the enterprise eventually succeeds or fails.
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