With the rise of popular television shows such as “Shark Tank” and “The Profit,” many new business owners are attracted to the idea of exchanging equity in their businesses in order to raise capital. This funding option is now commonplace – at least on TV – so it’s often a first thought in an entrepreneur’s mind when the need for capital arises.
But there is another option: borrowing money. Instead of giving up equity, some companies opt to borrow money, which has a few key advantages over giving up equity.
For starters, debt is typically less expensive than giving up equity in the long run because equity costs you a piece of your business.
“Think about it like this: when starting out, your small business needs inventory and equipment and to make payroll. Investors are going to help you with capital, but you’re sacrificing future profits indefinitely to fill a short to mid-term need,” writes Eyal Lifshitz on Entrepreneur. “With debt, you incur interest costs, but it is temporary and capped. Once you pay it back, your equity remains intact.”
Second, debt can be cheaper than your opportunity costs because you can profit from debt and open up new growth channels. The question, Lifshitz says, is this: “Is the return from this investment higher than the cost of the debt available to me?” Whenever the return is higher, the debt is worth it.
Third, paying interest on debt reduces your tax burden. The cost of interest actually reduces your taxable profit, which ultimately reduces your tax expense. The net result is that you’re paying lower effective interest than normal.
Finally, debt encourages discipline, particularly in the formative and growth years of a company, because it creates an environment of thriftiness throughout the business that could ultimately put the company on track for better margins.
Crestmark has broad experience in providing working capital solutions to growing businesses. If you are exploring options for your business, give us a call today to speak with a lending expert!