Thursday, May 14, 2015

When Is Debt Better than Issuing Equity?

When is debt use better than equity use for a small business?
When should I nearly always use debt instead of issuing equity?

I wrote this in response to a journalist's request to answer the following: 

Question: When is it better to take on debt than to issue equity?

Answer:

If your small business has sufficiently high cash flow to repay a loan for a specific item, such as construction equipment or computer hardware, that will help your company increase its profits and cash flow within that payback period, your business should take out a loan. Alternatively, you can utilize lease financing.  Why do I say this? Because your loan is backed both by cash flow from your business and collateralized by the asset. Therefore, the interest on the loan (typically ranging from 6 -12%, depending on several factors) will be significantly less expensive than the return on investment expected from an equity investment (typically ranging from 25 - 40% for investors who are not family or friends). In addition, the risk of not being able to pay back the loan will be minimal.
Do you have additional small business financing or related questions you'd like me to answer? Please feel free to provide them and I'll start answering one per week, beginning next week!



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