(ThyBlackMan.com) In the first Money Month articles we introduced the money month series and listed what we will be talking about. In the last money month article I asked you the very serious question of, “Are you even ready to get funded?” If you are new to the series I encourage you to go back and read them so you can be up to speed.
Now we start getting to the good stuff! MONEY…MAN!
In this article I am going to talk you about the two primary ways businesses are funded, equity and debt. This is going to serve as a framework for a deeper look at each funding source in future articles. You will have a general understanding of each type of funding source and be able to start thinking about which might be right for you when you finish this article.
Equity & Debt Financing…Big Differences!
Equity Financing
Equity and debt are the ways most businesses are funded. Equity financing means that you are selling part of your business to an investor so you can use their invested money to fund your business. Most of you are probably
familiar with the stock market. When you buy stock in a company, that is a form of equity investment. Stocks are small pieces of ownership in a company. In exchange for that stock you give the company money, which they use to fund the operations or growth of the business.
ALL EQUITY INVESTMENT is someone giving you money in exchange for some piece of ownership in your company. YOU MUST REMEMBER THAT. When someone invests in your business they become a part owner. So you must really ask yourself do you want a business partner even if they are silent? Do you want to give up ownership and maybe some control of your business.
How does it work?
When someone invest in your company they are doing so to get more money back in the future. This usually occurs in two ways. The first way is through a percentage of the profits. For example, if you have a business that requires $100,000 dollars and the investor puts in $10,000 dollars (10%), they may expect 10% of all the net profits of the company.
The second way that investors make money is when they sell their ownership of the company in the future. Picture an investor investing $10,000 to buy 10% of your company when your company is worth $100,000 dollars. Let’s say you go gang busters and the next year your company is worth double or $200,000 dollars and the investor wants to sell his or her ownership. Selling at 10% of the new price, $20,000, might be a simple way the owner pays the investor and get’s back ownership in the business. That would be a $10,000 gain for the investor.
What are Investors Looking For?
Investors are looking for five key things when looking to invest in a small business:
1. Leadership – Who is leading the company, what is there background and have they been successful.
2. The Plan – What is your business plan or model? Has it been researched, is it reasonable, can it be done?
3. The Market – What is the market for your product or service and how well have you researched and determined it will be a profitable market. Who is your competition in the market and what is your strategy to outperform them.
4. Financials – What are the past financial records of the company or the future projections of the company. If they are future projections have they been researched and are they reasonable?
5. Return on Investment – Investors want to MAKE MONEY. They will want to know when they can get their money back, how they can sell their piece of ownership when the time is right and how much over all will they make from the money they put into the company.
Key principles on equity investing
- Do You Want to Share – When someone invests in your business they are buying ownership in your business. Do you want to share ownership?
- Will They Make Money – Investors are looking to make money so they expect to get a percentage of the profits or they expect the company to grow in the future. Can you make a case that you can make money for them?
Debt Financing
Most of us are more familiar with debt financing than equity financing. We have gotten loans for cars, houses and lines of credit with our credit cards and borrowed in other ways.
How does it work?
Debt financing is basically paying to use someone else’s money. It consist of principle, which is the actual amount you borrow and interest. Interest is how much you are paying to use the bank or finance companies money. Interest is how those companies make money. If you take out a $10,000 loan for 7% interest over 5 years, your total payment back to the bank would be $11,880 dollars. You would be paying the bank $1,880 dollars to use their money.
What are lenders looking for?
1. Credit Score – If you are a small business owner there is no such thing as a ‘company credit score’. They still look at your personal credit score and if it is too low they will not fund. For banks, they usually look at credit scores of 660 or higher. For other types of funders they usually want a 600 credit score at minimum.
2. Ownership Equity – They want to know how much you have personally invested in the business. Most business loans require you to put in at least 20% of your own money into the business. So if you need $10,000 the bank expects you to put in $2,000 and they will lend you $8,000. This can vary by who is lending and what type of loan you get. We will discuss this in a later article.
3. Collateral – Collateral is what the bank gets if you don’t make your payment. It could be business equipment, business property or even your personal property. Bank and lenders lose big if you can’t pay the loan back so they want to make sure they can take something of value and sell it if you can’t.
Key Principles on Debt Financing
- Check Rates & Terms – When you are borrowing money for your business you are paying the lender to use their money. Be very careful that you check the rates and terms. The lower the rate the better and the longer the term the better.
- Lenders Want Their Money Back – Lenders look in detail at your loan request to make sure they have a great chance of getting paid back. This means they will look at your credit, how much you have put in the business on your own and what collateral is available.
So you have learned the basics of equity and debt funding for your business. Over next few articles we will take a deeper look into specific types of equity and debt financing. We will talk about which type is right for your business, based upon the size of your business and needs. We will talk about how to make your business pitch to each type of investor or lender.
Part 1;
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Staff Writer; Dell Gines
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