Debt or equity? Featured

11:53am EDT March 11, 2004
Sometimes I forget that entrepreneurs aren't always savvy in finance matters. I was reminded of this recently when I spoke with two bright entrepreneurs. The pair are making a success of their Internet-related business and are looking for ways to finance their expansion.

Shortly into the conversation, it became evident that they were total novices at finance, but smart enough to admit they needed help and accept a brief review of Finance 101.

Most experienced business owners take their understanding of financial matters for granted -- they've been doing it for years, and the balance sheet has become their accepted bedfellow. But there are many entrepreneurs whose background as engineers, scientists and inventors never prepared them to understand the difference between debt and equity. And for them, it's worth taking the time to make sure they get it right.

Most people are familiar with the concept of debt --it's money you owe and that is securitized, meaning there is some collateral that the person or entity owed can seize if you default. Typically, this is handled through a loan of some sort.

Equity is typically thought of as bringing aboard a partner -- selling a portion of your business to raise capital. You don't have to pay the money back, but you are no longer the sole owner of your business. Examples of equity are issuing common or preferred stock and selling membership or partnership interests.

To determine which method of financing to pursue, consider how the money raised will be used. If you want to buy equipment, debt is probably the way to go. Once you pay it back, you've completed your obligation.

But when you opt for the equity financing route, investors provide funds under the belief that your company will prosper and their investment will become more valuable. Investors are not merely financing the purchase equipment, but are financing the operations and growth of your company. And for that, they become partial owners.

Your decision should be based on how you want to run your company in the future rather than what you simply want to accomplish today. Erwin Bruder (ebruder@gordian.org) is president of The Gordian Organization. Reach him at (216) 292-2271.