Should you fall into unsustainable debt or give away a portion of what you have ? This is the hypothetical question that sometimes plagues the owners of small businesses. Unfortunately for them, their choices are severely limited by the fact of their size and the isolation of their business segment.
The answer to this question can have profound implications for both the business owner and the business itself. If they get it wrong, bankruptcy will be knocking at the door. If they get it right, their business will weather the storm and may go on to develop into a rather successful venture.
In any case they have to confront this choice at some point or other. This article will look at some of the dynamics that come into play when a firm is choosing between handing over a portion of business equity and undertaking debt.
Debt has to be repaid
This sounds simple enough but there are some business people who somehow believe that the world owes them something, believe that the government will intervene if they are too desperate. They may also think that they will only pay those debts which they want to pay.
Even more so for the business than the private individual, the moment you take a debt, the repayment schedules and requests become a hanging reminder of your obligations. The lenders will already have details of your sureties and collateral so it is only a matter of time before they can fully recoup their debt. They will ensure that either way they make more profit than you and you make more losses than them depending on how well you have run the business during the duration of the loan.
Therefore taking out a loan is not the easy option. In any case the rather stringent criteria for lending will almost certainly keep out a large percentage of people. It is quite possible that the bank will not be willing to take a risk with your business if you are already reporting some problems with your business. A business credit rating is as real as an asset. If you are known as a serial borrower who struggles to repay their debts, then you will almost certainly not be in a position to ever acquire another loan. You will be in effect blacklisted by the lending companies.
Can equity come to the rescue ?
With business equity financing, you are merely inviting interested parties to join in the ownership of your company for a set period of time. Obviously some people do not need or want to have anyone involved in their private businesses. However business equity finance might be the last solution available. It does not necessarily involve debt but can allow you to release some of the value in your business.
A third way is to combine debt and equity financing. This means that you reduce the overall risk of this corporate finance initiative. However you should also be aware that lenders will look with some skepticism at any equity finance arrangements you have and they may conclude that you are over committed anyway.