Business Finance – Shares and Equity

Date: 2009.11.16 | Category: Business Financing | Response: 0

The term equity finance refers to share capital that is invested into a business for the medium to long term in return for a share of the ownership and in many cases an element of control over the running of the business. There are two main forms of equity finance available to businesses. These are business angels and venture capitalists. Equity finance is fast becoming one of the most popular ways of gaining start up finance for businesses.

Equity finance is the perfect example of true risk capital. This is because there is no guarantee that your investor will ever get there money back. Unlike lenders equity finance investors don’t normally have the rights to interest or to be repaid at a particular date. The way in which equity investors regain the money that they have invested into a company is through taking a share of the business and a percentage of the profit. It is because of this high risk involved in equity finance that if your business can not support growth rates of at least 20% you may not be able to attract equity funding. Equity investors are more likely to invest in someone they feel they can trust with a clear business plan and strategy.

As a business you need a clear business plan and strategy regardless of what type of business start up finance you are hoping to attract. You need a comprehensive business plan with a detailed marketing plan and your financial forecast. Your business plan needs to address issues such as how much funding you are going to need and how much control you are hoping to retain over your business. You also need to clearly state what you are using your business start up finance for as well as if your plans are realistic and if your venture is appropriate for outside funding. Whilst you are completing your business plan you also need to consider what potential investors may be concerned about. Without all of this; plus much more no potential investor will go near your business, planning is key if you are hoping to secure external funding.

If you are hoping to gain the financial help of an equity investor there are several questions that you need to keep in mind such as are you prepared to give up some of the shares within your business as well as part of the control over your business? Investors will expect to have some say in the way in which your business is run so you should be prepared for this. You also need to be confident in your business and the products and services that your business has to offer, one way in which you can do this is by identifying what your businesses unique selling point is. As well as this you also need to have the necessary industry skills and experience to drive your business.

For more information about what equity finance can do for your business get in touch with a business angel or venture capitalist today and they will advise you on what to do next.

Helen is the web master of Angel Start-ups [http://www.angelstartups.com/articles/showarticles/BusinessFinanceArticles/4/InvestmentFinanceStrategiesBusinessOpportunityLoan.html], specialists in all aspects of Equity Finance [http://www.angelstartups.com/content/venturecapitalists.php].

Business Financing FAQ:

Question: Is it possible to receive full financing on a small business loan?

Answer: Years of successful industry experience is always a consideration….unless you have hard assets that can fully secure the loan.

Question: How can I arrange financing to expand my own business?
Need to expand my existing small manufacturing business. We manufacture Shock absorber components in India. Looking for opportunities to market the components here in USA. Do you know who are major shock absorber manufacturers in USA and what approach can I take to solicit business from them.

Answer: For money your options are either taking on partners, securing money from the bank or looking into venture capital. Tenneco has Monroe autoparts division. I believe they are the largest shock company in the US.

Question: How would someone with bad credit get approved for financing to start a new business?
I want to start my own tanning salon and espresso stand. I personally have a low credit score and limited start up funds. I have a few locations in mind and after much research I know that this business is VERY profitable, yet…VERY expensive to start up. Where could I find financing to get the start up funds?

Answer: Look for investors. If you can demonstrate that the business is as profitable as you say prepare a business plan and advertise for investors. You will have to give up a substantial piece of the action, but if you don’t you probably won’t have a business at all.

Question: In buying a business, should I obtain financing before I negotiate a price?
Or should I sign a letter of intent first, get financing, and then go forward with negotiation? What are the steps in buying a business? What are the pit falls and things I should look out for?

Answer: Firstly you need to know how much finance you are able to raise, then you can negotiate with letter of intent in offering. But you need to fully examine all aspects of the intended business before purchase or even making an offer. This entails going to a business accountant to have him run over books etc, then having Lawyer/Legal rep look over legalities of what pitfalls he can see. Insurance would have to be involved as that is a major part in any business purchase.

Question: I just retired and want to start a tree trimming business and would like to find financing. Any tips?
Where do I look for financing and where would if find a checklist that would help me is getting the things that I need to start this business.

Answer: The best routes to take are to research the process of starting a business as well as the industry you’re interested in. I recommend checking out the SBA, Entrepreneur, The Start Up Journal & Nolo. All 4 are great informational resources for the new/small business owner. I posted links for you in the source box.

Associations may be a good avenue to explore. These organizations will address many of the thoughts, questions and concerns you’ll inevitably have as well as many you haven’t anticipated yet.

Research, research, research – this cannot be stressed enough. Read as much as you can about the industry. There are plenty of free informational resources out there.

Question: Does anyone know how to get 100% financing to start a business?
I would like to open a franchise but I have no money down and not really any assets. I am looking for someone who finances 100% to start up a business.

Answer: Talk to your franchiser. They may have some ideas. If not, your best bet is Small Business Administration, although success is by no means guaranteed.

Question: How do you get financing for a business venture?
I am a 22 year old in college, and I am looking at starting up a new private business. However, I am broke. Is there any way that I can get a loan from a bank or get involved with angel investors? If I wanted to get about $30,000, how could I go about acquiring it? Any help would be greatly appreciated.

Answer: First make sure what ever you are doing you have all your bases covered before approaching any one. If it is something new TRADEMARK IT! Then when speaking with any one- have them sign Nondisclosure -Non Compete agreement first. As far as “Angel” investors are concerned a lot of them prefer “Tech” or some kind of tangible business that can produce fairly quickly. Most investors like the “Principal Party” to have some form of equity stake. It is tough, as far as $30,000 is concerned, you are in college- If you could round up 300 people at $100 each- you have what? Get some parties going, talk to local bars get them to let you use the bar a night a week-charge cover, convince the owner to do have price night, etc etc and keep the cover as a fee to promote the place and tell the owner to give a % off the register that night. IT IS SO EASY to do something along those lines.

Question: How do I find a financing company to work with our home improvement business?
The business does renovations on homes – kitchen/bathroom updates, adding dormers, etc. But some people aren’t able to afford the full price of the renovation up front. How can I find a financing company that would be willing to partner with our business to get loans for the customers?

Answer: Talk to the bank where you have your business account.

Business Start-up Finance For Your New Venture

Date: 2009.11.12 | Category: Business Financing | Response: 0

When it comes to starting your own business one of most important factors to take care of is your start-up business finance. There are many funding options open to you, with the main forms being categorised as either debt finance or equity finance.

It has been said that roughly 60 or 70% of all new business ventures call on their local bank as their first attempt to gain start-up finance. Gaining a bank loan to fund a business start-up is one form of debt finance. This debt finance comes in the form of a bank loan that typically has to be repaid at an agreed interest rate. The way in which banks usually agree to bank loans is by securing your loan against an asset. The way in which this works is if your business then fails to repay the loan, the bank can then claim the asset. So what exactly is this asset? An asset stands as usually a house/premises or equipment that is owned by your business.

The main problem with a bank loan is your company then becomes locked into a tight payment schedule that could cause problems for small businesses. There are also other forms of debt finance that are starting to prove just as popular with small business, such as credit cards and leasing. The term leasing refers to the borrowing of money to buy specific equipment/machinery. In this case small businesses borrow against the store sales.

All forms of debt finance means that you are borrowing against reserves rather then giving someone ownership of your shares. The main thing that you have to keep in mind when it comes to debt finance is finding the aspect of funding that is right for your business; there is however one flaw to this theory; what if no form of debt finance is right for your business? To answer this predicament I bring to your attention, equity finance.

Although the definition of equity finance slims down to pretty much being risk capital, it is the saviour of many small/new businesses who are either turned down for a bank loan or merely can’t keep up with the repayments.

Equity equals true risk capital as there is no guarantee that the investor will get there money back. The big advantage however is that the money that is invested into your business from equity finance never has to be repaid. Investors to your business are prepared for risk capital in return for a growth share of your business profit.

The investors behind equity finance give you the money that you need to get your business off the ground and to cover all aspects of your business start-up costs such as rent, the purchasing of equipment and staff wages as well as all of your utility bills for the first few months.

Whatever finance you decide to use for your business venture, make sure you make a realistic and informed decision based on your business needs. There is a lot to take into account and you need to ensure that you have all of your business information sorted before making any decisions.

Helen is the web master of ARCH Entrepreneurs, specialists and experts in all aspects of Business Finance.

Business Financing FAQ:

Question: How dose equity financing work for small business?

Answer: The short answer is that “equity” means ownership. Equity financing means that an investor would provide some money to the business in exchange for part ownership.

Question: What is the definition of “group equity” in business/finance terms?

Answer: I am not familiar with this term, at least not in the context of your question. If you are referring to an LLC or partnership, perhaps it’s the amount of equity you and your partners have in the business cumulatively.

Question: Financing a business with no collateral?
I have few patents and I want to start a small business based on one of these patents. Banks require collateral and/or equity which I do not have. Can the patents be used as equity since Patenting is expensive and cost me tens of thousands of dollars.

Answer: No, the patent may have potential value. It is not a commodity that can be priced, bought and sold.
Maybe you should look to venture capitalists for financing. Those people are experienced and interested in helping start up companies get started, if and when they recognize the potential. Bankers charge interest on loans. That is all they get out of any deal. Bankers get scammed all of the time and are wary of people with new ideas.
For a piece of the action, investors put up the cash, and look for profits well above and beyond the amounts the banks can make on loan interest.

Question: How does the federal income tax structure impact a business decision to finance with use of debt vs. equity?

Answer: In both cases, there is usually a payment for use of the money. A person who lends money(debt) expects to be paid interest, while a person who invests money(equity) expects to receive dividends. The payment of interest for business purposes is deductible, while the payment of dividends is not. For the person receiving the payments, qualified dividend income may be taxed at a maximum of 15%, while interest income is taxed at the recipient’s normal tax rate.

Question: Nervous about asking bank for business financing for a new liquor store. Need 100K and have $15,000.?
Have been planning every single detail of a liquor store for 3 months and I am finally getting to the point to where I ask a bank for a 100K loan. I have $15,000-$20,000 of equity in my house. Have business plan, experience with liquor (3 years as liquor manager), perfect location, name and logo, and cheapest/best vendors to buy pens to registers to 8 door walk in cooler (checked over 5 vendors for everything). Don’t like to be embarrassed or to look like an idiot if I have not a chance in hell to get the money. What should I do to make my chances better?

Answer: You should definitely do it! Show them your experience and how you have everything planned out! Liquor stores do pretty well because, well, people like to drink! If you are still a little nervous just think the worst that can happen is they say no and you’ll never see them again!!

Question: How do I find sources of Business Financing?
I am looking for ways to find small business financing. I am not looking to borrow 100K+. I want to only borrow $25,000 to grow my company. I am not look for VC sharks or loan sharks. My experience is that the SBA is nothing but red tape. Anyone have any ideas? My company is profitable (about 7,500/month NET) and it’s based in the Philippines.

Answer: Opt for applying for specific loans in your search. For example, if you need office equipment or other equipment, seek equipment financing or leasing from companies that specialize in those areas.

Question: Is there small business financing available that will not effect you personally if your business goes under?
I want to open an ice cream shop in my area but I do not want to put my house up for collateral in a loan or if the business goes bankrupt for the lender to be able to come after my personal assetts. Is there financing available? Or anyone know of grants to open a shop.

Answer: If you open your business as an LLC (limited liability corporation), you can get a loan on the LLC, and then if the business goes under they can’t tap your personal assets. This is why an LLC exists.

However, you’ll need a solid business plan and a willingness to put some of your own assets into the business.

Question: What is the best way of financing for a new open business when you have no credit and cannot borrow from bank, friends or family?

Answer: You need to save the money or borrow from family or take partners. Financing is the hardest part of most businesses. Unless you have a very simple service business you will have cost. The simple service business is what they call low barrier to entry like cleaning houses, mowing lawns, babysitting, many people can do the labor and the equipment is cheap so most have almost everything they need.

Using Home Equity For Debt Consolidation Might End Up in Losing Your Home!

Date: 2009.11.12 | Category: Home Equity Financing | Response: 0

When the burden of debt becomes unbearable, you search for all options to get rid of it. One tempting option is using your home equity. It’s simple and easy. Your credit card debt will melt in no time. But remember, it is a double edged weapon.

You may buy your first home in the beginning of your career. You make your mortgage payments promptly. Real estate market also moves up gradually. Over a few years, you build up a good margin over your mortgage. That is your money and you will require it for buying a bigger house or for moving to a posh locality. This is an investment for your retirement also.

However, over the number of years your habits may change. You may go on spending a lot with the help of those ‘powerful’ credit cards. But in the periods of downturn, these credit cards are hard to maintain. With higher interest rates, unreasonable fees and penalties you end up with huge balances on your credit cards. Your income is unable to cope up with re-payments.

There are companies offering instant solutions to get rid of such situation. Their solution is – take loan against your home equity and pay off the entire debt.

You can take such a loan in two ways – either use a home equity line of credit (HELOC) or use a home equity loan (HEL). Both these loans are easy to get if you have built up a good equity over the years. However, you should take such a decision only after weighing major risks.

1. This loan is against your home. If you are unable to pay it off in time, there is a risk of losing your home. You will be quickly spending the loan amount towards discharging debt but if your spending habits continue, you may create further credit card debts in a short time.

2. Consider the market price of your home. If the real estate market is falling, the value of your home may go down and finally your mortgage plus home equity loan may exceed the value of the house. This is a trap of bankruptcy.

3. Your monthly payments on home equity loan will be lower than the payments for your credit card dues. However, the repayment period may be longer and you will have to make the monthly payments regularly all the time.

4. Determine the exact amount outstanding on your credit card. If you are taking your home equity loan, take only the minimum required. If you are planning to take the home equity line of credit, be very careful while spending that money. You may be tempted to use this money for spending further! That will be a very dangerous move.

You should always remember that this loan is second mortgage. It is backed by the security of your home. If you make any defaults, there is a risk of losing your home. Moving from your own home to a rented apartment is never a good idea.

Credit cards have become a part of life. However, with heavy rates of interest and fees, the total burden of debt becomes unbearable. Even the thoughts of the huge outstanding balances may scare you. Instant solutions like home equity loans are offered by finance companies. But are these solutions safe? Chintamani Abhyankar analyzes in detail.

Chintamani Abhyankar, is an expert in the field of finance and taxation for last 25 years. He has written many books explaining inside secrets of the magic world of finance. His famous eBook Stop donating your money to IRS which is now running in its second edition, provides intricate knowledge and tips on personal income tax.

Home Equity Financing FAQ:

Question: What is a home equity loan and what is the process to applying/being accepted for one?
I paid roughly $90,000 for my home. I’ve fixed it up in the past 9 years dramatically. New roof, new walls, siding, porch, heating system, well etc. My home and property was valued at $275,000 last year. Does equity play a part in this. Am I eligable for an equity loan? I’m looking to build my own home–hence the loan inquisition.

Answer: An equity loan is a loan against the difference in your home’s value and any outstanding liens you currently have (like your 1st mortgage). The new equity loan takes a 2nd lien position to your 1st mortgage and is sometimes called a second mortgage, which is the same as an equity loan.

Some banks and direct lenders require “seasoning” which means you have to own your home for sometimes 12 months before you can use the new value. Therefore I recommend you seek the assistance of a mortgage broker. Brokers work with several different lenders and will have options available to you right now. They can also explain the various types of equity loans available and can offer rates that are the same or lower than local banks. They also have several “no-cost” loans as well.

Since you’re looking to build a home, you may not need all your equity out at once. I recommend an equity line of credit where you can borrower and pay for only what you need when you need it. Equity lines can be fixed or variable, have interest-only payments or include principal payments. Again, talk to your local broker to get all the details.

Question: Should we wipe out savings or go with home equity line of credit to finance home improvements?
My husband and I are debating how to finance some home improvement projects. He says use savings, I say use a line of credit(repay within two years hopefully) I am afraid if we use savings we will never replace it. He doesn’t want debt. Any opinions?

Answer: If you got the equity then go with the HELOC. If the home improvements are going to increase the value of your home then it’s a no brainer. As long as you’re not going to buy a car or take a vacation with it. Leave your savings alone.

Question: Ability of using equity to finance down deposit on new home?
I have a substantial amount of equity in one of my homes, and am looking to purchase a second home sometime in the summer. I do not have money for a down payment, however, I do have more than enough for closing costs. I was wondering if it would be advantageous to take out equity on the one home for the 20% down payment on the second home. Do mortgage companies frown upon this action, or is it encouraged? Would I get advantageous interest rates in this case, or similar rates as to doing 100% financing? Just so you know, the home I am looking to purchase is a duplex, however, it will be a primary residence. I know interest rates are generally higher for duplexes. Just a thought I had, wanted to know if it would be worthwhile to leverage the one homes equity to purchase the new home.

Answer: I just did that about seven months ago…except I went from a duplex to a single family home. The major advantage of using your equity to purchase more property is that you can avoid pmi with 20% down and conventional financing. The major disadvantage is that a home equity loan is fairly expensive. I borrowed 90k against my equity and it costs me almost $700 a month. I bought my new home through a bank and got approved before the home equity loan even hit my credit so they couldn’t complain about it! If you think your duplex will cover the cost of the mortgage and the home equity loan than go for it! Otherwise you will be footing the bill for the second mortgage on your primary home.

Question: What is the difference between a 1st mortgage, 2nd mortgage, and home equity loan?
I am searching for financing to make home improvement repairs, I submitted a request for a home equity loan through lending tree. The lenders throwing out terms such as 1st mortgage, 2nd mortgage, and home equity loan.

Answer: A first mortgage is a loan secured by the property that is in 1st position and gets paid what is due them first if the property is sold (municipal liens like property taxes are TRULY first, though).

A second mortgage is a loan that has a “junior” position behind a first mortgage. Home equity loan is just a colloquial term generally applied to second mortgages. A HELOC, or Home Equity Line of Credit is a TYPE of home equity loan that acts more like a credit card in that you can draw on the equity as needed and pay it back and draw on it again and again during the “loan” term.

Technically you can have 3rd, 4th, 5th, etc. mortgages and any of those could be a “home equity” loan in that they would be loans secured by remaining equity in the property, but that would be highly unusual on a residential property.

Question: Is a home equity loan a good idea for financing my new business?
I am a web developer and am thinking about quitting my day job and starting my own company. I’ve got some clients lined up already but need some financing to pay for startup costs such as equipment, supplies, and my office lease. Dipping into personal savings is not an option since there isn’t much there. We’ve got a good amount of home equity. Would a home equity loan be my best option for getting the ball rolling on my business?

Answer: Based on what you are trying to start and having some clients already lined up, I would recommend you start doing some of your work in the evenings and on weekends. You can work from a home office, even if it is just a computer on your kitchen table. You can meet with your clients at starbucks, you can buy equipment and supplies on a credit card (find one with no interest for 6 months to help you finance) and stay away from an office lease until you absolutely have to get one. Think about the entire cost of the lease vs the monthly. If you sign a 12 month lease for $2,000 a month you have just committed $24,000 to your new idea. You should not have a lot of start up expenses in this type of business. Try to do it on current income and some short term borrowings. Think about your home and your retirement account as retirement investments.

Question: How do you cash out of a home that has equity in it, and what sort of financing agency do you go to to do this?

Answer: Treat it like any other first mortgage loan. Get the best deal you can from a conventional lender.

Question: Is it possible to re-finance a home equity loan?

Answer: It depends on your credit, and the value of the house in relation to your equity. I would ask several lenders about your particular situation. Not all lenders have the same rates and solutions available. If you have lost too much equity, you may still have options with some government programs, or renegotiating your loan with your bank. If you can’t make the payments, sometimes your only option is to sell. If you have no equity left in the house, it is still possible to sell in something called a short sale. If you need to do a short sale, I suggest you find a Realtor that knows how to negotiate and manage a short sale. You have a limited amount of time, and to succeed, you need expert advice.

Question: Where is my best chance to be approved for a home equity line of credit?
I’ve slipped and let my credit score get a little low. Today I applied for a home equity line of credit through CITI where I have my first mortgage and was declined. I would like to obtain this loan to payoff credit card debt and get my finances under control. Where or what financial institution is my best chance to be approved for a home equity loan or line of credit?

Answer: Ask Citi why they declined it and then work on the areas you need to improve to qualify for this type of loan. Be careful not to run from one bank to another, every time they check your credit your score drops even further. If Citi, who holds your mortgage, does not approve you then chances are no other bank will do it either.

Ask yourself: Do you have enough equity built up in your house? What is your house worth right now. Compare listing prices of similar homes in your area. How much of the mortgage is paid off already? If you bought within the last 5 years chances are you still owe too much to qualify for a home equity line of credit.

Cut up the credit cards and start paying them down. The times when you got a HELOC to pay off the cards are over.

Commercial Finance – Debt Vs Equity Financing

Date: 2009.11.04 | Category: Debt vs Equity Financing | Response: 0

Financing is financing, right? A loan for a business is just like a loan for a home, right? Unfortunately, this simply isn’t the case. Commercial financing is an entirely different game compared to personal financing.

Sooner or later, you are going to need financing as a business. It might be to get up and started. It might be to finance materials needed to fulfill a large order. Whatever the reason, it is vital to understand that there are two basic forms of commercial finance for businesses – debt financing and equity financing.

Equity financing is the most common choice of newer businesses. Why? Well, the statistics are fairly ugly. Something between 70 and 90 percent of all new business fail within two calendar years from the date of launch. As a result, traditional commercial banks are loath to invest in newer companies. The risk is just to big that a default will occur.

So, what exactly is financing and who does it? Well, equity financing is not really financing at all. It is the sale of pieces of ownership in the business to drum up money. For most small businesses, this means tapping into the bank of Mom & Dad as well as lightly twisting the arms of friends. For businesses with bigger ideas, angel investors or venture capitalists can also be sources of funding. The primary issue to keep in mind, however, is once that equity is sold off, the business is no longer “yours”. It is owned by a group and a group that wants to make a profit.

Debt financing for a business is much more like personal financing. You are usually dealing with a bank. Assuming your company has been around for a bit, the bank will be receptive to chatting with you about your financing needs. That being said, it is not going to give you a general loan. Commercial debt financing usually is tailored to a specific need. If my business needs to buy a piece of equipment, the lender will give me a loan for that specific piece of equipment.

There is one area where commercial banks will provide more general financing to small businesses. This is in the form of a line of credit. These lines can be a blessing and a course. First, they are expensive. Second, they tend to be watched closely by the bank. You might have a million dollar credit line, but you will rarely get to use it all. If the bank sees your balance going up towards the limit, it will often call the line. This means it will essentially demand payment within a specified time. If you do not make it, the bank will come after your assets since it required you to personally guarantee the line. This is something you see happen with service companies, such as law firms, all of the time.

So, which form of financing is better for your business? If you can swing it, debt financing is by far the best. Giving up ownership interests in your company should be avoided, which makes equity financing a Faustian bargain.

Stephen Teak writes about financing through commercial loans for small and big businesses alike. Read more of his work at CommercialLoanStop.com.

Debt & Equity Financing FAQ:

Question: Equity vs Debt Financing. For a large business which is preferable?

Answer: That really depends. Debt financing requires getting an outside loan, and the company must pay it back plus interest. Equity financing requires using some of the company (or owner) ownership to someone else, which means that the company will have yet another person with different ideas who has ownership in the company. On the plus side, equity financing doesn’t require putting up any assets.

Large businesses are probably going to want to use equity financing, such as issuing stocks, which many already do.

Question: Equity versus debt financing of a foreign subsidiary?

Answer: Both alternatives depend on the foreign country that is the subsidiary’s market. If you choose borrowing, the interest rate prevailing there would be very critical (as measured against the-higher-the-better inflation rate); so would be the exchange rate and a lot of other country risk measures. You must not borrow in excess of the borrowing capacity of your subsidiary. The last thing you want is excessively high interest burden especially if too much cyclicallity is inherent in this foreign country or the industry your subsidiary pursues. The equity alternative can be less appealing because of the typically higher required return but still higher equity serves as a buffer against losses and conveys less interest burden. All in all you need to analyze both your subsidiary’s business and market very carefully to assess the tradeoff.

Question: Compare Debt vs. Equity Financing for a business.

Answer: Debt financing means borrowing money that is to be repaid over a period of time, usually with interest. Debt financing can be either short-term (full repayment due in less than one year) or long-term (repayment due over more than one year). The lender does not gain an ownership interest in your business and your obligations are limited to repaying the loan. In smaller businesses, personal guarantees are likely to be required on most debt instruments; commercial debt financing thereby becomes synonymous with personal debt financing.

Equity financing describes an exchange of money for a share of business ownership. This form of financing allows you to obtain funds without incurring debt; in other words, without having to repay a specific amount of money at any particular time. The major disadvantage to equity financing is the dilution of your ownership interests and the possible loss of control that may accompany a sharing of ownership with additional investors.

Question: What is the difference between debt and equity finance, and what exactly is structured?

Answer: When a company needs money it can take on debt, eg borrow money from a bank which then has to be repaid.
Or it can issue more equity, (i.e. shares) and this is equity finance. It does not require repayment.
A structured loan is one having a definite structure, eg 60% loan and 40% equity, the loan payable in equal amounts over 3 years.

Question: What is the risk involved in other financing situations such as selling bonds, issuing stock, venture capital, debt, and equity financing?

Answer: The risk in selling bonds is if you default on the bonds you will have to file for bankruptcy liquidate your assets in order to pay your creditors before you are able to recoup anything for your business. Creditors have first crack at liquidated assets.

The risk in issuing stock is the diminished ownership in your venture and the requirement to please shareholders and depending on your company this may get tedious.

Venture capitalists often demand exorbitant returns on their money, often 200-300% over a short term period (3 years). So you can see all your profits go directly to a venture capitalist.

Debt financing is a different way to say selling bonds and equity financing is a different way to say issuing stock.

One other option is to find an angel investor, someone willing to offer in most cases a smaller contribution than a venture capitalist but often an unfettered contribution. Look for philanthropist types who are interested in seeing small businesses succeed, or family members.

Question: Financing fixed assets using debt funds is beneficial for a company or through equity funds?
Being a financial consultant of a company what will be my advice as to how to finance their fixed assets…either by using equity funds or by using debt funds?

Answer: That would depend on the rates of debt and equity. Both of these methods have equations, and you select the balance that you feel gives the minimum amount of risk and maximum return (this is called capital structure).

Generally, debt is cheaper.

Question: What is the proportion of debt financing for a firm that expects a 24% return on equity, a 16% return on asset?
Taxes to be ignored.

Answer: You need more information than that. If you’re trying to derive a proportion of debt, you need the WACC, the cost of equity, and the cost of the debt to determine the weights.

WACC = Weight of equity * cost of equity + weight of debt * cost of debt.

Once you have the cost of debt, you can solve since you know the weights have to add to 100%, there’s only 1 variable left.

Question: How does the federal income tax structure impact a businesses decision to finance with use of debt vs. equity?

Answer: If you’re using a leveraging formula, you need to take the tax rate into account along with the interest on the debt in order to have return on assets as well as return on equity. The impact is that interest on your profits are taxable, while the interest on your debt is deductible. (Corporations using capital budgeting will usually use a 35% tax rate, their highest.)

The Difference Between Debt And Equity Financing

Date: 2009.11.03 | Category: Debt vs Equity Financing | Response: 0

There are two main types of financing for a business, debt or equity financing. Debt financing tends to be the type of financing you receive from a traditional bank loan and equity financing tends to be financing you receive from venture capital into your business from outside investors. The benefit of debt financing is that it is finite and you will pay down the debt over time to a zero sum balance without any further obligation to the lender. The down stroke to debt financing is that traditional lenders will take a hard look at your business including how long it has been in existence, income from operation, expenses and will require hard assets for collateral for the loan. Additionally, lenders will most certainly want you (and any other principals of the organization) to personally guarantee repayments of the loan. Another disadvantage of debt financing is that your organization will be burdened with some other type of regular payment (usually a monthly payment) depending on the terms and conditions of the financing and this can absorb critical cash flow, especially with small business.

The benefit of equity financing or venture capital is that you will be receiving money in exchange for equity in your business in the form of stock or some other form of equity like percentage of income or gross/net sales. A primary benefit of this type of financing is that typically there is no monthly payment requirement to investors. Instead, you are giving up ownership interest, most often, permanently.

Traditional lenders, banks for example, will look at your business much differently than venture capitalist. Bankers want a zero-risk or near-zero risk position when they provide financing and will rely almost completely on the operating economics of the business with little regard for “potential future growth”. They want to see strong cash flow backed up by hard assets before they do a deal—the ingredients that most small business lack or they wouldn’t be seeking financing, right? Venture capitalist, on the other hand, tend to consider the management team and the potential future growth of the business more heavily than actual operating numbers, especially for small business with large potential but few sales and little or no operating history. Although these two lender types vary in their approach to analyzing a business for funding, you can be sure that careful scrutiny of you business will be conducted.

Besides the actual operating economics and pro forma analysis, both types of lenders will look closely at two particular documents: 1. Your business plan. 2. Your bank or loan request package. These two documents, if assembled correctly, can make the difference between success and failure when dealing with either lender type.

There are plenty of free SBA related materials that tell you how to create blue-chip, boiler plate business plans but they tend to be written for perfect businesses and not the average Joe who is less than picture perfect. If you are seeking some type of financing for your business I strongly suggest that you visit our site and check out our business e-books. We have several that cover a variety of topics and there are specifically two that will be a real treasure for you to own. One is called Power Planning (a powerful report on writing a wide variety of business plans) and How To Raise Money For You Business (teaches you how to assemble professional loan requests packages). They are priced at $5 each and can be worth millions in the hands of the right person. I am not trying to hype product, I am simply giving you a heads up.

The secrets to getting financing from either type of lender is a closely held secret by financial and business brokers for a number of reasons. Chief among them is it forces people like you to do business with them and they earn commissions. The SBA materials, while good, do not have the street savvy to get the job done in most cases. The proof is in the pudding—what has the SBA ever done for you? The SBA is just another government back bureaucratic nightmare for most. We also have some links for venture capital firms in our business links area located on our site on the Smart Link Zone page—it’s all-free.

Give it some thought…. Your future may depend on it.

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Debt & Equity Financing FAQ:

Question: What might be an appropriate middle ground between debt and equity financing?
Debt financing is more risky than equity financing, but equity financing is more expensive.

Answer: It really depends on what you’re looking for and how much you need. I don’t know if I definitely agree that debt financing is more risky and equity more expensive. In a start up situation, it really depends on the entrepreneur–what kind of credit background do you have, how much capital do you have, what is the market potential, etc.

Usually, an appropriate middle ground is a balance between the two. Obviously, in a high risk situation like a start up, the risk inherent to debt exists mostly when the borrower must use his or her home or possessions as collateral. If that’s the case, it’s probably better to go solely with equity. If the venture is less risky, say for example a franchise, then borrowing is also less risky, and therefore probably better. In either case, you’ll want to borrow from whomever you can get the most favorable terms–usually family, friends, and fools, if they can put up the money–and get equity from the people with the most experience and contacts since equity investors will take a direct role in the company. You should chose equity partners not only for the money, but more importantly for the experience and contacts they add.

Question: What are the advantage and disadvantage of debt financing and equity financing?
My company has been talking to a consultant and I need to know what the advantages and disadvantages are before I make any moves!

Answer: Here are some considerations:

Debt Financing – Advantages: interest payments are tax deductible, there is no dilution (decrease in ownership) to existing equity holders. Disadvantages: the debt holder has FIRST CALL on all assets of the Company (in advance of equity holders) in case of a liquidation. Also, there are many covenants associated with debt instruments that may impact a company’s freedom of action. Of course, debt instruments usually have current payments required – which means if you don’t have current net operating income this can cause difficulties.

Equity Financing – Advantages: No current payments due; No preferential rights on assets of the Company. Disadvantages: Dilutes ownership of current equity holders; may result in control loss issues.

Of course, this presumes you use COMMON equity financing – if a Preferred Equity structure is used it can often mimic some of the characteristics of debt financing without the advantage of tax deductibility.

Question: What’s the difference between equity financing and debt financing?

Answer: Debt financing means you’re borrowing money and will pay it back (with interest). This can be through a loan, or bonds, or other types of debt.

Equity financing means you’re selling a part of your company in exchange for capital. This could be through partnership, stock, etc.

Question: Is there a difference in using debt financing or equity financing on shareholder value?

Answer: Equity financing is dilutive to existing shareholders. Excessive debt financing can ruin the balance sheet and lead to cash crunches.

Question: Compare and contrast long term debt and equity financing?

Answer: Long term debt is riskier at start up as there will be a definite cost through interest payments while equity is selling part of the business so you won’t have the same costs of interest. In the long run however, if the business is successful then debt would end up being a cheaper way to finance as a successful company will have its shares rise in value so your opportunity to get the full amount of this gain would be lowered by what you sold. Equity financing also has the added benefit of more owners who may have specialized knowledge and skills and would be willing to provide that skill as they hope for the business to be a success.

Question: What factors associated with debt vs. equity financing might influence price-earnings multiples?

Answer: It deals with the capital structure of the company. As the company has more debt and less equity, it’s more highly levered and thus more risky, leading to a higher P/E. With more stock than equity, there’s less risk, which would probably trade at a lower P/E.

Question: Explain why there is a tradeoff between debt and equity financing?

Answer: There is only a certain amount of money you need for a particular project. Usually the only money you can get is debt financing and equity financing, so if you get more equity financing, you don’t need so much debt financing, and vice versa.

Question: Would a company financing with debt or equity have a greater tax shield effect?

Answer: Financing with debt provides interest tax shield as interest expense is tax deductible, whereas if financing is done by equity, the dividends distributed are not tax deductible.