As you start to build your business from garage to office, the issue of funding will become abundantly clear.
So which road should you go down: building debt or equity? While many experts feel that equity is the way to go, as you’re not starting out in the red, I believe that smart business owners should raise debt instead.
While seeking out investors is an exciting idea, you’re giving away pieces of your company before you even know how valuable it is. You’re better off seeking out a loan that you’ll be able to pay off — and still be 100 percent in charge of your future.
Here’s why I feel a prudent loan is so much smarter than seeking out investors when you’re just starting out.
This, in my opinion, is the biggest factor. You, the entrepreneur, will have full say in how your company is run if you start out funding through a loan instead of through giving away equity.
You have the vision for your company. Especially at this early stage, you need to keep a steady hand on the tiller. By seeking out investors for your company, you could be killing it before it has the chance to get off the ground.
Too many new entrepreneurs who go the equity route are raising money from friends and family, not seasoned business leaders. They’re more concerned with how much money they’ll eventually make, not how they can add to your company. It’s a lot of weight you don’t need. Like the old saying goes, you’ve got too many cooks in the kitchen.
When you arrange for a loan through the bank, the institution has no control in how you grow your business. You’re able to set and manage expectations for your business.
Best of all: When you’re able to pay back the loan, your business partnership with that bank ends.
Easier To Map Expenses
Additionally, when you go the debt route over building equity, it’s easier to map out your expenses.
You’re able to include your debt as a line-item expense, making financial calculations that much easier. However, when you’re doling out equity, it’s hard to accurately map out percentages.
When you’re just starting out, the last thing you want is a bookkeeping headache. By going the debt route, it’s easier to get a clear picture of what you owe. You’re able to work with the bank to get a finite payment each month, knowing exactly how much principal and interest you’re paying back — and how long it’ll take.
You can finance a short-term or long-term loan, giving you an accurate road map of how long you’ll be indebted to the bank. The same cannot be said if you go the route of private investors.
And as I’ve said before, once it’s paid back, you nave no more obligations to that source of funding.
Additionally, the benefit of taking out a loan is most apparent when it’s time to do taxes. In most cases, the interest payments you’ve made are tax-deductable — a major help for entrepreneurs just starting out and small businesses.
Paperwork is Simpler
Lastly, I recommend taking it a loan over raising equity because it’s very easy to put together a promissory debt agreement — and much more cost-effective.
Raising equity can cost an entrepreneur anywhere from $10,000 to $50,000 in paperwork alone, cutting into your profits. Wouldn’t you rather have that money to dedicate to your business?
With a promissory debt agreement, you can have an attorney put one together for a fraction of the cost of what it takes to formally arrange for an investment. There are even sites online that have form promissory debt agreements, putting the power back in the hands of the entrepreneur.
There’s just far less paperwork involved for those who go with debt over equity, as they aren’t required to send periodic mailings to investors, hold shareholder meetings or seek shareholder approval. Making an agreement with the bank is just so much more of a straightforward process.
While it might seem like a great idea to go to your friends instead of go to the bank when it comes to funding your company, a closer look will show that a loan is the better option for new entrepreneurs. I’ve seen too many start-ups fail because the true costs of raising equity can bury them, and soon friends and relatives have a say in how the company is run.
With a loan, you have a clear timetable to repayment and the ability to be laser-focused on what matters most: your company.
The opinions expressed here by Inc.com columnists are their own, not those of Inc.com.