Some entrepreneurs succeed in making million, if not billions, more than others by being careful not to sell too much of their business too early.
If an entrepreneur obtains venture capital financing early in the life of a business, it is typically at a huge cost. In exchange for this financing, the start-up’s founders will have to sell part of their company, thereby diluting their ownership. The decisions entrepreneurs make at this stage can have wide ramifications, not only for their future success but also for their profits.
Maintaining Your Share of Future Profits
As smaller companies begin to expand into new markets, they require capital to be able to take advantage of emerging growth opportunities that will significantly appreciate the value of the business and its equity. These smaller growth companies need to be careful not to sell too much equity at this stage. Based on appreciating valuation multiples that these growth companies can realize upon exit, equity will usually cost the business excessively more than debt, and will commonly also be accompanied by highly restrictive operating and board control provisions.
When Debt Is Preferable to Equity
To expand, a business needs ready access to capital. If you are a business owner, debt financing may be preferable to equity financing if you:
- Have limited ability to raise equity due to size, market conditions, or dilution impact.
- Do not want to substantially dilute your ownership interest in your business at this stage.
- Do not want to surrender a share of future profits of the business.
- Prefer not to relinquish operating control or strategic direction of your company and/or its Board of Directors.
- Want to finance your business quickly without long lead times and uncertainty of closing.
- Want to shield part of your business income from taxes. (If you finance your business using debt, the interest you repay on your loan is tax-deductible.)