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When an entrepreneur comes up with an innovative idea that may require financial resources greater than what he or she possesses that team may need to raise capital for the business. Business leaders and founders can use equity, debt (take out a loan), convertible debt, build via blockchain and offer crypto tokens, or a combination to raise funds to help with the continued 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 the 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 will have fixed or monthly payments, including interest, to the investor and provide preference for payment in case the business files for bankruptcy. Loans can be difficult to attain, or come with very high interest rates, as a new business has little to no credit history. In the United States 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 can convert into a specified number of shares of common stock in the issuing company or cash of equal value. It is a hybrid security with debt and equity-like features.

What is a Cryptocurrency Security Token Offering

An Security Token Offering (STO) is a form of initial coin offering (ICO) or initial currency offering is a type of funding using cryptocurrencies in a regulated fashion. In a 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. Historically traditional paper backed assets like equity shares or debts in a business presented some transaction and liquidity issues. This type of business funding event in the form of a token can address some of these issues.

How are they different?

Debt investments tend to be less risky than equity investments, but with lower and more consistent returns. Debt financing allows an entrepreneur to retain control of their 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 still provide the investors with potential impressive returns as well as an alignment of incentives.

Equity investments involve higher risk, but with possible higher rewards. Equity financing means issuing shares of common stock to an investor. With more shares of common stock, the investor's ownership increases. Unlike with debt financing, entrepreneurs do not have to channel profits into loan repayment. There is also no requirement to pay back the investment if the business fails.

Which one should you use?

We review Analytics offerings to help analyze performance on either side of the market, investor or business owner. Leveraging these platforms are lowering fees like businesses loans with better rates online, lower fund management fees and transaction costs, and more. The choice of financing depends on the type of business, cash flows, profits, expansionary needs, and the creditworthiness of the founders. If you are considering debt financing a good place to start is a business credit score. 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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