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How Should I Finance My Business?

How Should I Finance My Business?

By BRAD PALMER

In Hamlet, Act I, Polonius says “neither a borrower or lender be”. Obviously, Shakespeare did not like debt. The U.S. tax code and Federal bankruptcy law, however, does like debt since all of the interest on a business loan is fully deductible, and most debts can be discharged in bankruptcy court. So the question arises, should I finance my business purchase or startup with debt capital, equity capital, or some combination thereof? Here are the basic answers to this question.

Equity Financing

If you borrow money to purchase or start a business, it is virtually certain that you are going to have to personally guarantee the loan. If the business fails, barring filing bankruptcy, you are going to have to repay the loan. The advantages of debt financing are that the interest is fully deductible, and as the loan is repaid, you build equity in the business. When the entity is eventually sold, the entire proceeds of the sale are yours. Additionally, you have total control over the day to day operation of the enterprise.

Equity Financing

Equity financing consists of your own funds that are used to begin the business, as well as monies belonging to outside investors who expect a return on their investment, as well as eventual repayment of the investment. There is, however, no legal obligation on the part of the promoter to pay the investors anything if the business does not succeed. Regardless of whether you decide to purchase a business or start one if you choose to go the equity financing route, you are almost certainly going to have to relinquish a majority percentage of the equity to the investors, especially if you are investing little or no capital of your own.

Equity, Not Debt

It is extremely important if you decide to go the equity route that the legal documents clearly state that the investor’s investment is equity and not debt. Never accept equity capital on the proverbial “handshake” since if the business fails, the investors will often claim that they loaned you the money and that they want repayment. If you organize your business as a limited liability company, the operating agreement is the controlling document, and if you are a corporation, then the articles of incorporation control. Finally, if you are an employee working for a promoter who asks you to accept a below-market salary in return for equity, never agree to this without the arrangement being in writing since dishonest businesspersons will often deny that they agreed to this years down the road if the business is successful and is sold.

This article is not intended to be a rendering of legal, accounting, tax or other professional advice. Assistance from a competent professional in these specific fields should be sought. 

#FinanceaBusiness #BusinessFinancing #NJBusiness #CrownBusiness #BradPalmer

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Equity Financing


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