Entrepreneurs´s Journal


May / June 2004
Debt or Equity – That is the Question
By Emily McHugh

Deciding how to finance your business is a personal decision. It depends on many factors, including your personality, your level of discipline, and your business type. Also, your financing decision is a function of your desired growth velocity, your desired level of control, and your patience. At the end of the day, it often becomes a question of control. In equity financing, one of the “rewards” for giving up control is to have the opportunity to grow faster, and to have a crack at the all-important “first mover’s advantage”. But equity financing is not for everyone and not appropriate for all types of business. If your business is highly capital intensive or research driven, e.g., you want to roll out a national chain of tea parlors, or develop a cutting edge killer app, then you may need the deep pockets of an acquiescent venture capitalist. But if you can slug it out and grow organically without selling your first born, then, you may want to carefully consider the alternatives before taking the equity plunge.

Now, before you get the impression that it has to be either debt OR equity, remember that finance is all about being creative, you may need both. Understand what you are doing and be aware of the pros and cons of each. Above all, set your OWN agenda and be honest with yourself. This holds true no matter what method of financing you use.

It is a basic component of business to need financing of some sort or another. Financing is a means to an end, not the end in itself, unless of course, your business is banking. Therefore, it would be productive to spend less time worrying about debt or equity, and more time achieving positive cash flow, which is the ultimate goal. This should be the entrepreneur’s focus from day one. Doing this helps maintain a firm connection with reality.

So what is an entrepreneur to do, you still need cash upfront before you are able to sell. The obvious starting point is to estimate how much cash you really need for specific stages of your business. Then decide whether you can do with less. Statistics show that one of the chief causes for many start-up failures is being under funded. However, it would be naïve to assume that being well funded is an automatic guarantee for success. As evidenced in the late 90’s, over funding start-ups can also be a recipe for disaster – Ikea furniture and banner ads do not a business make.

Hence, I am a big fan of boot strapping. It builds character and fosters the traits necessary to grow an enduring and profitable enterprise. Remember, Rome was not built in a day. Bootstrapping demands extra discipline since you will have to do more with less. It requires diligence and the frugal use of resources. Firmly ask yourself the question - if an expense cannot be offset or matched, either directly or indirectly, to a cash producing result that leads to profit, then how do you justify the expense? This is an important question to ask at all times.

Using debt prudently is a highly advantageous way to start a business. Knowing you have debt to re-pay makes one more likely to take the business seriously and to find a way to make it work. The intelligent use of credit cards is key in this equation. The secret of course, is to pay those balances in full every month and never pay late!! If you cannot do this, then do not use credit cards. Credit cards can be one of the biggest blessings to the entrepreneur because as a revolving line of credit it gives rewards with use. But it can also be the biggest curse if not controlled and used to your advantage. When you exhibit that you are responsible with credit and that your business is growing, then ask your bank for a line of credit at a low interest rate. Here you can afford to carry the balance, because it is cheap to do so. (Tip: many banks are having “loan sales” now, so this is a good time to ask.)

The key to debt is to use it as a tool with the objective of constantly reducing it so that you can obtain even more access to credit. When the day arrives when the demand for your product exceeds your ability to finance it from cash flow or even debt, then we can start talking about equity. But that still does not mean you sell your soul!

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