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This is an update to an article originally written in 2014 by Kimberly Dodson.

When an entrepreneur comes up with an innovative idea that requires financial resources greater than what they have they will need to raise capital for their business. Business leaders and founders can use equity, debt, convertible debt, build via blockchain and offer crypto tokens, or any combination of these to raise funds to help with the growth of the business.

At Fund Wisdom we review innovative funding and investing options and the changing market dynamics that accompany them. These funding platforms are creating greater transparency and market insight on what businesses and investors are using for funding sources and how successful they are. Depending on the entrepreneur and your vision for the business, certain methods of capital will be more appropriate than others.

What is Debt?

Debt through bonds or notes can be acquired through loans. Debt requires fixed or monthly payments (including interest) to the investor, and provide a preference for payment in case the business files for bankruptcy. Loans can be difficult to attain or may come with very high-interest rates, as a new business has little to no credit history. In the US a government program called the Small Business Administration (SBA) can help secure loans.

 

What is Equity?

Equity offerings provide business capital with no immediate need to pay back investors. Equity investments are securities that provide a stake in the company. Shareholders are rewarded through the retained earnings of the firm and have a claim on the assets of the corporation after the debt holders.

What is Convertible Debt?

Convertible debt is a loan that can convert into equity. The holder of the debt can convert the notes into a specified number of shares of common stock in the issuing company or cash of equal value. It's a hybrid security with debt and equity-like features.

What is a Cryptocurrency Security Token Offering

A Security Token Offering (STO) is a form of initial coin offering (ICO, or initial currency offering). It’s a type of funding using cryptocurrencies in a regulated fashion. In an STO, cryptocurrency is sold in the form of "tokens" or "coins" to investors in exchange for legal tender or other cryptocurrencies such as Bitcoin, Ethereum, etc. The tokens sold are promoted as future functional units of currency and are done so following SEC-mandated rules. An ICO can be a source of capital for startup companies. Traditional paper-backed assets like equity shares or debts in a business present some transaction and liquidity issues. This type of business funding event in the form of a token can address some of these problems.

How are they different?

Debt investments tend to be less risky than equity investments, but with lower and more consistent returns. Debt financing allows you to retain control of your business; entrepreneurs do not lose creative or strategic control of their startups. Startups may have to back up a loan with collateral, which means that if the startup defaults, it could lose certain tangible assets. Convertible debt delays the need to perform a valuation as a startup, but it still provides the investors with potential impressive returns as well as an alignment of incentives.

Equity investments involve higher risk, but with higher potential rewards. With equity financing you issue shares of common stock to an investor base and the number of shares offered dictates the investor's ownership percentage. Unlike with debt financing, you do not have to consistently allocate profits to loan repayments. There is no requirement to pay back the investment if the business fails with a loan.

Which one should you use?

Careful analysis of offerings can be performed with data market data insights solutions. These products can be used to help analyze performance on either side of the market, investor or business owner. Equity and debt investing platforms are lowering fees providing better rates online, lower fund management fees and transaction costs. When selecting a path to raise funds consider they type of business you are in, your current and future cash flows, profits, expansionary needs, and the creditworthiness of your founding team.

If you are considering debt financing a good place to start is with a business credit score. Yalber offers up to $500k in 48 hours and Lending Club offers some of the lowest rates. If you are considering debt financing and have issues with your personal debt check out these tips by LearnVest. As businesses grow they typically employ a blend of both equity and debt financing to meet their needs when raising money. Which method of raising funds works for you? Share in the comments below.

 

Photo credited: Anna Dziubinska

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