It takes money to make money. Deciding where to find the first funds to get a startup off the ground is one of the most important decisions an entrepreneur has to make. We asked 12 startup founders what advice they would give an early-stage entrepreneur who’s considering debt vs. equity. (Share your own thoughts in the comments.)
Consider sweat equity first
When you take on any type of investment from someone else, you’re forfeiting some of your control of the company by default (even if you don’t do equity, you’re still obligated to your creditor). Because you raise capital, ask yourself if you can do this without the investment, especially if the venture is web-based. Chances are, you can. Investment is overrated anyway — customers matter more.
Try your best at debt first
I’m a big believer in keeping as much control over your business as possible. Debt — in the forms of lines of credit or loans — is an effective means to build up short-term capital while keeping 100 percent of your business. Having investors with equity shares is like having many bosses, and you risk losing control.
Sponsored by VB
Decide if you’re in this business forever
If this is it — the big idea that you want to work on long-term — debt may be the best option. You need to keep control when something is your baby and you plan to work on it forever. But if you’re looking at building this business and then moving on to something else cool, equity looks like a better option. It means people are already interested in your company and may be willing to buy you out.
Remember, equity is clean
When going through your first round of fundraising, often times you will come across convertible debt notes versus equity. Equity is the cleanest term versus a convertible debt, because it is risk capital that doesn’t have to be paid back. With a convertible you have to pay it back or it gets converted into equity and comes with extra terms. Cost of equity can be higher though because of dilution.
Evaluate your position
There are several factors to consider, although I would suggest that accepting either debt or an equity investment is entirely situational. Sometimes you won’t have a choice, frankly. You should look for strategic investors that have access to more capital, more investors, and industry specific connections. I would also hire an attorney with expertise in structuring investment deals.
Be thankful you have a choice
At the end of the day, when you need money for that next big step and you have found someone willing to fund you, your say in the matter is rather limited. Remember the golden rule for startups — he who has the gold often makes the rules.
There’s no single right answer
Each option has its pros and cons. It’s crucial to evaluate both the debt and equity options, get formal terms for each, then decide which makes more sense for the future growth of the business.
Avoid debt if possible
A startup’s break-even point is one of the most important, yet often neglected, measurements. If a company can become profitable early on through hard work and niche market penetration, a certain type of momentum is garnered — that is indescribable. Going into debt, on the other hand, forces the entrepreneur to always be looking backward at the lenders waiting to be paid back.
It depends on the terms
Debt vs. equity depends on the terms. If it’s unsecured debt and even close to near-market rates, the deal would seem pretty attractive.
Share equity for less risk
We bootstrapped for the first 18 months before finally taking on a few equity investors. We generate a lot of sales, so debt is a great option (we can use the cash from the sale to pay it down). However, I made a personal decision that I had taken on enough risk in investing my time and money into my company. Instead of adding more debt (and personal guarantees), I decided to share the upside!
Make a big, big pie
Many early-stage entrepreneurs worry about losing control of their business when taking on an equity investment, but issuing equity can help your company get to the next level. The right investors aren’t bosses, they’re partners who are incentivized to help you succeed. They’ll make introductions or help you with strategy. It’s better to have a small slice of a big pie than all of nothing!
Do What’s Best for Your Business
The right method to finance the next phase of your company should come down to the kind of business you’re in. We used convertible debt early on (via an accelerator), but there are plenty of early businesses in which that might not make sense. Ask other entrepreneurs for advice (and mentors, if you have them). This kind of decision is very non-general; make the decision that’s best for your team.
The Young Entrepreneur Council (YEC), an invite-only nonprofit organization composed of the world’s most promising young entrepreneurs. The YEC promotes entrepreneurship as a solution to unemployment and underemployment and provides entrepreneurs with access to tools, mentorship, and resources that support each stage of their business’s development and growth.
Money image via Shutterstock
VB’s research team is studying mobile user acquisition: Chime in here, and we’ll share the results.