Debt vs. Equity Financing Explained

Transcript

Regina Campbell: What is the difference between debt and equity financing? Well, if you think about it, it's probably a little more traditional than you think. Debt financing is a company's use of banks, loans and private lenders. Think about it as being similar to installment loans, loans in general that require payment on a certain fixed term. Some of these instruments don't have monthly payments back; they can have balloon payments. There are a lot of different structures of debt instruments that can work for your company.

And they offer some benefits. They offer the benefit that you don't have another owner coming in. You don't have to bring them on the board. They don't have the decision-making. You don't owe them a fiduciary duty per se, or at least only to remain solvent, or not to use the money improperly. But it also comes with the requirement that you have to make certain payments, which is sometimes hard with startup companies, because cash flow is usually very tight and not forthcoming until after a lot of development and the launch of the product in the market have actually happened. So often that's not really helpful for startups, but it is a solution to not have someone take over part of your company.

Equity financing is basically using the equity in your company to raise money for operational needs, marketing needs, development needs. And the person, in exchange, is getting equity. They're getting shares in the company. That's also good in the sense that you have someone who is interested enough in seeing the company do well that they want to actually invest in the company. They believe in it enough to do so. You can also use equity financing for sweat equity purposes, for attracting talent, management and investors.

But remember, when you're going to do this, a lot of times your company has to have certain operating agreements and certain structures in place. Depending on how much money the person gives you for equity, they may also require a seat on major decisions. They may require a seat on the board. They may limit what the company can do absent their approval, which could even include taking additional equity financing. So, as the proverbial saying goes, there are more strings attached to it. But there's more flexibility, in that you don't have to pay it back. You don't have to worry about having the operating cash flow to be able to pay it back.

And there's a combination of them, too. Sometimes you have convertibles that turn into equity. There are many different things you can have, but it's really up to the particular company and where they're at: how much control they want to give up, and their objectives overall, short-term or long-term, as to whether to use debt or equity financing. Often I find companies might use a little bit of both. It really depends what's best for you.

Interviewer: Thanks, Regina.

Regina Campbell: You're welcome.