Business Loans vs. Equity Financing

Business financing comes in the form of debt or equity.

Business Loans vs. Equity Financing
By Pierre Mouchette | Real Property Experts

Business financing comes in the form of debt or equity.  The difference between the two is:
Business Loan - is debt acquired after receiving funds from a lender who expects to be repaid with interest at some specified rate over a specific period.  Although each lending situation is unique, many banks utilize some variation of evaluating the five Cs of credit when making credit decisions:

• Character (Integrity) - The following is part of the character question:
  • What is the character of the management of the company?
  • What is management's reputation in the industry and the community?
  • Does management have impeccable credentials and references?
  • How does the management treat their employees and customers? 
  • Does management take responsibility for all their actions?
  • Does management fulfill its obligations on time?
• Capacity (Sufficient Cash) - The following are part of the capacity question:
  • What is the company's borrowing history and track record of repayment?
  • How much debt can your company handle?
  • Will you be able to honor the obligation and repay the debt?
• Capital (Net Worth) - The following are part of the general financial condition question:
  • How well capitalized is the company?
  • How much money do the principals have invested in the company?
  • Are the principals at risk in the company?
  • How do the company's financial statements read?
  • How far will the principal's resources support both themselves and the business as it is growing?
• Collateral (Assets) - The following are assets offered by the borrower as security worth:
  • While cash flow will usually be the primary source of repayment, lenders look at what they call the secondary source of repayment.  Collateral represents assets that the company pledges as an alternate repayment source for the loan.
  • Most collateral is in the form of hard assets such as real estate and office or manufacturing equipment.
  • Alternatively, your accounts receivable and inventory can be pledged as collateral.
• Conditions (of the Company and Overall Economy):
  • What are the conditions and circumstances peculiar to your industry or geographic area?
  • Are there any economic or political agendas that could negatively impact the growth of your business?

Equity is an ownership interest in a business - the Equity Investor(s) buy stock (in the case of a corporation) or take a partnership position.  Equity investors who are not actively involved in the day-to-day operations of a business are generally those who are investing with the expectation of rapid and substantial returns from the value of their investments.
 
Note:  Mezzanine Financing is a hybrid of debt and equity financing.  Mezzanine Financing is typically used to finance the expansion of existing companies.  Debt capital gives the lender the right to convert to an ownership or equity interest in the company if the loan is not paid back in time and in full.  It is generally subordinated to debt provided by senior lenders such as banks and venture capital companies.

• Mezzanine financing is usually provided to the borrower very quickly with little due diligence on the lender's part and little or no collateral on the borrower's part.  This type of financing is aggressively priced, with the lender seeking a return in the 20 percent to 30 percent range.
• Mezzanine financing is advantageous because it is treated like equity on a company's balance sheet and makes it easier to obtain standard bank financing.  To attract mezzanine financing, a company must demonstrate a track record with an established reputation and product, a history of profitability, and a viable plan for the new business.