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Debt vs Equity
As someone who finances start-up businesses (as well as existing businesses), I often get approached by entrepreneurs looking strictly for investors to finance their business; angel investors, private equity, and venture capital funding. I always appreciate entrepreneurs with the courage to dream about investors being as in love with their idea and start-up as they are. There are, however, other options, that are oftentimes more realistic and attainable. It’s important that business owners truly understand the difference between debt and equity financing and what to consider when making this funding decision for their business.
What is equity financing? Equity financing is giving a portion of ownership in your company to someone in exchange for money; the most common form of equity financing is when a company goes public and sells shares of stock to increase their liquid capital (cash). Equity is the right fit for some situations, but private equity financing can be very difficult to obtain and generally you need to be an established business with proof of concept and revenue before you can attract that type of financing. The number I’ve heard quoted time and time again from investors is that fifteen out of every 1,000 pitches they hear will actually receive any type of equity financing; that’s only 1.5%, meaning 98.5% of those looking for equity capital will never receive a penny from an investor.
What is debt financing? Debt is sometimes looked at as a “4 letter word”, but debt is only negative when it’s used improperly and irresponsibly. Debt is simply money that is borrowed and needs to be repaid, generally with interest.
So, why use debt financing? Since there are so many options available for this type of financing, most business owners can find a capital solution that they qualify for and that meets the needs of the business for both its short and long term goals; it’s generally much more applicable to the needs of the average business owner and allows for more freedom with the use of funds and business decisions. Additionally, since there are many types of debt financing, you can utilize multiple solutions simultaneously, which allows for higher dollar amounts and more flexibility to accomplish your goals.
Something else that is vital to consider: although debt financing is money that needs to be repaid, you’re not giving up a piece of your company. I’ve heard so many stories of people giving up a majority share of their company and then feeling like they’re being held hostage in their own business, or that losing control of something they’ve worked so hard to build. I’ve also seen situations where people give up too much equity for too small of an amount of capital, when if they’d taken a loan to start with instead, they could use that capital to grow their business, making it far more valuable, and end up giving less equity for more money.
Separation Business and Personal Debt
A very common (and costly) mistake that I see many business owners make is a failure to separate business and personal debt and credit. Entrepreneurs are eager go-getters by nature, and are ready to jump in and get started with their business the moment they have their EIN and all their corporate documents. Many business owners mistakenly assume that getting a corporation set up is all they need to do to protect their personal assets. If you are putting business expenses on your personal credit profile, like a credit card or HELOC listed under your name and social security number, you are opening yourself up to personal liability and the risk of fines and other government penalties. Just as you set up a corporation to protect your personal assets, you need to set up your corporate credit profile to protect your personal credit, and completely avoid commingling any and all personal and business expenses.
There are many reasons to keep the two separate: firstly, as mentioned, this protects your personal credit profile; any debt going under your SSN instead of your EIN shows up on your personal profile as personal debt, which will artificially inflate your credit utilization; this will cause your credit score to go down, since your debt-to-available credit ratio and your debt-to-income ratio will show as higher than normal. Additionally, lenders offer different terms and higher loan amounts for funds being used for business purposes because they know the money will be used to make more money; you’re not taking that credit card, for example, and going on a shopping spree, you’re using it to invest in your business. So, having credit lines under the company offers benefits exclusive to businesses.
A much more serious consequence, however, is that convoluting the two can end up piercing your corporate veil. As any corporate attorney will tell you, this can result in personal liabilities, both legally and financially, if something negative happens to the corporation. It can also incur IRS fees if you’re audited, and revocation of your corporate status with the Secretary of State. Of course, we always hope for the best, but as a diligent business owner, you must be prepared for unfortunate circumstances, whether that be financial distress within the business or legal matters that may arise in your company.
By separating the two, you are also starting to build your corporate credit profile and Dunn & Bradstreet, which is very important as your business grows and you need to borrow larger sums of money and layer your financing further. Building a corporation’s credit will allow your business to borrow without a personal guarantee (also called a signature loan).
So, how do you do this? Separating the two from the beginning is easy: just ensure you are always applying for and taking financing that is specifically for business use and reporting under the EIN, not your SSN. Oftentimes, a personal guarantee is needed, and personal credit is pulled and reviewed during the application process (until you establish corporate credit). When the loan is taken, however, it does not show as available credit or debt under your personal credit profile. The only exception to this is in the event of a default on the loan, that is really the only situation business debt can negatively impact your personal credit profile.
So, what if you haven’t separated the two? What if you’re in business and have already put expenses on your personal profile? The best option is to see what you can obtain for business funding and use that to pay off anything that is a business expense that was paid for using a personal credit card or other personal debt instrument. This has to be done on a case by case basis and can take some time and expertise, so consult with an expert for available options and the best way to get this debt off of your personal profile and under the business.
Equipment Leasing: What Does It Mean?
You’re a tradeshow manager looking for equipment to help with an upcoming show or you’re looking for equipment to help with you current flourishing business, but, purchasing equipment sounds too costly. It’s until then a coworker suggests leasing equipment from numerous companies. Before you make any final decision, you decide to do extensive research on equipment leasing. What does it mean, is it expensive, and how it is more beneficial are all questions we will answer throughout the article so you don’t have to do endless hours of research.
Equipment Leasing 101
It can be a common mistake to assume leasing and borrowing are interchangeable terms under a business spectrum. One distinctive difference between these terms is the monetary compensation to the lender for leasing equipment. Generally, you pay a flat-fee rate with a fixed interest rate and fixed term. Many companies seek the leasing route compared to purchasing, especially if they only plan to use the equipment in the short-term. Purchasing tends to be more costly and may not be worth a large payment as the equipment will continue to depreciate.
What kind of equipment can be leased? You may be imagining large tractors or machineries as equipment to be leased but equipment can be a broad term and can cover from pcs to vehicles for all types of businesses.
- When leasing equipment, you won’t have to worry about a down payment or collateral unlike purchasing it. There is no requirement to contribute collateral so you will have the liberty to collect your cash and compensate easy payments.
- Worrying about an application process undergoing a long strenuous time-frame is all overwhelming, but luckily, leasing equipment is an easier application process. There is fairly less financial paperwork compared to taking out a small business loan.
- Leasing equipment offers a couple of flexible terms to choose from after the lease ends:
- You can purchase equipment at a fair market value and if you do, the lender will then relinquish the title to you.
- If your equipment has come to its last bit of usefulness, you can trade the current item to a brand new equipment piece.
- If none of the options above seem ideal to you, you can always choose to do the simple option, return the equipment.
After you’ve chosen to lease a piece of equipment, you begin your flat fee payments but you will also have to face an effective interest rate alongside it.
Another downside to leasing equipment is the cost of the actual equipment, especially when multiple factors are considered (credit score, annual revenue, age,etc.). There will also be a charge of equipment value and length of use for the equipment.
Need to Lease Equipment?
As we have gone over, equipment leasing provides various benefits for those who need equipment for a shorter period of time. Here at Strategic Business Loans, we offer numerous opportunities from small to big businesses to continue flourishing in their business without a financial predicament. Contact us today for equipment leasing and continue to grow your business.
Working Capital Loan: What Does it Mean to You?
It’s not uncommon for small businesses to find themselves in a dire situation when they lack sufficient funds to continue their business and daily functions. Luckily enough, a working capital loan helps those who need to purchase operational activities without risking your liquid assets. We care about all types of businesses in their success and offer several types of loans to support business owners like you. You may be wondering what exactly a working capital loan is and what it means to you and your business, throughout the blog we will overview the highlights of the capital loan and how it may save your business.
What is a Working Capital Loan
As previously said, working capital represents a type of loan to either small, medium, and large businesses who are in need of money to cover certain expenses. Whether it may be electricity expenses to short-term financial payments, working capital loan serves to help businesses strive in their market without the anxiety of overdue payments.
One common misconception about a working capital loan is it covers all long term assets and future investments. In truth, this loan only supports day to day operations and to overall, assists your business in its financial function. Fortunately, this loan does offer a low-interest rate so you can avoid another financial dilemma and begin financing your long term assets.
In order to decipher how much capital loan is needed to cover the rest of your expenses; all businesses require calculating a working capital ratio. The calculation is simple as is since a business will only have to calculate current assets divided by current liabilities. If your ratio is below a 1.2 then it’s time to consider reapportioning your budget and taking out a loan, but if it's greater than 2.0 then your business is right on track and all financial outlets are evened out.
As a small business, it’s important to be informed on the beneficial factors to being financed by another loan. Earlier in the blog we mentioned the perk of low interest rate compared to other loans with high interest rates, but, capital loans offer other benefits as well.
- No Collateral Required: Unlike other financial loans, working capital offers businesses the financial benefit of relief from expenses while no requirement for collateral. It’s understood the financial responsibility you must uphold and it may seem more difficult to provide collateral along the way, luckily, you won’t need to abide by these certain loans and instead focus on a steady low interest rate.
- Immediate Loan: While other loans take weeks to months for approval, working capital provides an efficient process for those who seek financial assistance immediately. No longer worry about a tedious approval process and attain the appropriate amount of funding to continue your business.
As it is important to inform yourself of the beneficial factors to a loan, it is also dire to understand the financial risks.
- Repayment Timeline: Just as you are able to take out a loan immediately, you are also liable to pay back the loan in a fast manner. Payments are low-interest rate but require immediate deposits.
- Possible High Interest Rate: If you have a poor credit history then you may have to pay a higher interest rate with long term payments. Generally, lenders must ensure a low-risk of repayment by instituting a higher interest rate but do offer low interest to those who have a good standing.
Grow Your Business’s Potential
As business owners, we hunger for growth and abundant opportunities for our business. It’s time you ensure the continuation of your potential by applying for a working capital loan, so you won’t find yourself in a financial predicament. Contact us today for future endeavors and expansion to your business.
Small Business Loan: Types of Loans
In the state of California, we are known to be one of the most difficult states to flourish in businesses; most particularly small businesses. California may be one of the most recognized states of struggling small businesses but it’s also famously known for employing more citizens in the past few years. Small businesses generally fail after a few years, if not carefully planned and financed optimally. Join the rate of successful businesses in California by taking out the appropriate loan for you.
You may wonder which loans can help best serve your business without finding yourself stuck in an abundance of debt. Look no further, throughout this article we will go over SBA, or most famously known as small business administration loans, and detail how these loans can help your business.
What Is SBA?
Before we list the types of SBA and benefits to the loan, it's crucial to understand what small business administration loan means and what it can do for you. As the name suggests, SBA is meant for small business loans carried out by the SBA and banks acting as the lender by distributing an amount to small businesses.
The lenders or banks guarantee flexible terms and interest rates so you may continue to grow your business without being perplexed with overriding debt. There are several types of loans a business can qualify with different pros and cons for each one.
Types of Loans
Curious which loans you qualify and the benefits to them? SBA offers various loan programs for businesses to flourish in but we will cover the 3 most common loans a business can apply.
- 7a Loan Program: Most commonly used, the 7(a) loan guarantees a term loan of up to $5 million. This loan can be used for either working capital, to refinance debt, buy a business, real estate, or equipment financing. Since they do offer a high working capital to businesses, there are more restrictions corresponding with the loan. Luckily, they do offer a long repayment with low interest rates to make your financial responsibilities affordable.
- 504 Loan Program: This type of loan is generally meant for those who wish to purchase or improve fixed assets. Fixed assets may include purchasing land, machinery, facilities, etc. Instead of one lender funding these projects, this type of loan requires two lenders, either one from a bank or traditional lender. The loan itself does not cover the entire fund but, instead, covers a majority while the borrower must include collateral damage for the rest.
- Microloan Program: While the other two loans are backed by traditional lenders or banks, microloan is supported by non-profit organizations who lend their finances to other small businesses. These funds cover working capital, inventory, equipment, business start-up, etc. Their maximum principle is about $35,000 with a term of 6 years while interest rates range from 8%-13%.
Want More Information?
Businesses are requiring more funds as regulations and daily operations eat a large part of their financial stake. Let us assist you in this important financial time and help you relish in success. Contact us now for more information on small business administration loans and see which best suits your needs.