Equity or Debt: Questions Entrepreneurs Should Ask

This is another awesome Guest blog post from Andre Averbug.

In a previous post, I covered the kinds of investors that support startups. In the last post, I discussed the different types of financial instruments available to startups. But how does an entrepreneur know which type of instrument is ideal for his or her business? Let’s now turn to the main questions one should ask when trying to decide between the two key instruments – equity and debt.

Whether raising capital through equity is right for you depends on how you answer the following questions:

  • Does your business have the potential to grow exponentially? Equity investors, such as angels and VC funds, will only buy equity in startups, i.e., companies that are working on scalable solutions and have the potential to increase the value of that equity substantially over the next several years. In other words, they will not invest in lifestyle businesses, which are businesses that may be successful and last decades, but without experiencing fast growth and giving investors an exit opportunity. Equity investors get their return when they sell their equity (exit) at a higher valuation to new investors, either private, such as a private equity (PE) fund or, if they are very lucky, through an initial public offering (IPO). Therefore, be realistic and ask yourself: Is my business a startup or a lifestyle business? By the way, there is nothing wrong with being a lifestyle business, and a friend or an uncle might even put some equity in it. However, professional equity investors will only invest in true startups.
  • How important is it for you to retain ownership? Some entrepreneurs are overly protective of their equity and want to maintain full ownership at all costs. This is usually not a good mindset, especially if you run a startup, given that sharing ownership with investors, management, and even staff might be key to the success of the business. You will need investors to help grow your business and more partners to align interests and have everyone onboard and working for the long-term success of the company. Remember, it is better to have smaller share of a highly successful business than 100% of nothing. So, if you feel you are the overly protective type, consider rethinking your approach – otherwise, equity may not be for you.
  • Do you work well with others and welcome mentorship and opinions? When you get equity partners you are embarking in a relationship that you don’t know how long is going to last and how smooth (or rough) it will be. Angels and VCs, particularly, will want to participate in key business decisions and often mentor you. They will likely want a seat at the Board. To maximize the chances of success for this relationship, be sure you can take opinions, you welcome feedback (constructive and sometimes not so much), and that you can share some of the decision making. Remember these investors are literally betting on you. They are putting money in the early stages of your venture, when risks are extremely high, and deserve – in fact, usually have the right – to have their voices heard. It doesn’t mean that they are always right and that you should avoid disagreements. Simply be open to healthy discussions.
  • How much support do you need, on top of the money? Equity investors usually bring a lot more than just money. They help you with corporate strategy and business development, open doors through their Rolodexes, provide industry knowledge, sit on your side of the table in major negotiations, such as sales, partnerships etc. If none of that seems important to you (really?!) and you strongly believe in your ability to grow the business on your own or with your current team, then perhaps taking a loan – if you can – would be the best approach. That is because, if your business is indeed successful, it means your equity will gain value over the years, and the cost of selling equity should be higher than taking debt.

When it comes to debt, these are some of the important questions to ask:

  • What is your current (and future) cash flow situation (projection)? You should not take a loan if you are not confident in your ability to commit to debt repayments, including interest and principal. If you are in the earlier stages of your company, have not broken-even yet, and don’t see it happening in the near future, perhaps debt is not for you. Debt requires some degree of predictability in your financial situation to ensure you can service it accordingly. For that reason, it is not a very popular instrument for early-stage startups (unless when offered in hybrid instruments such as convertibles), being more suited for later-stage companies and lifestyle businesses.
  • Do you have collateral (assets), credit history, or receivables? Banks and other lenders may still give you a loan if you don’t have enough cash flows. However, they are notoriously risk averse and will only provide you with a loan if they are comfortable with their ability to recover their loan, even if it means acquiring your assets to cover or minimize their loss. Therefore, even if you think debt is the right instrument for you, if you don’t have enough revenues, promising receivables, a credit history, or some collateral (machinery, building, inventory etc.) to borrow against, chances are you will not be able to get that credit.
  • Are you comfortable using collateral, including personal assets? When it comes to collateral, the question is actually deeper: It is not just whether you have it or not, but also if you are willing to borrow against it. Some entrepreneurs believe so much in their business that they literally bet their car or house on it! Even when the company itself does not have assets, the entrepreneur uses his or her own property as collateral providing personal guarantees to the bank. This is certainly not for the fainthearted and doesn’t make sense for everybody. Also, tragically, sometimes entrepreneurs expose personal assets without knowledge. Be sure to check the laws and regulations in your country to see whether your company provides you with limited liability or if creditors could go after your personal assets in case of debt default.

While this list of questions is certainly not exhaustive, it covers some of the key issues I had to ask myself during my fundraising experiences. If you have more ideas for questions, feel free to share them in the comments below!

 

Andre portrait

Andre Averbug is an entrepreneur, economist, and writer. He has over two decades of international experience working in the intersection of economic development, entrepreneurship, and innovation. He has worked and lived in multiple countries across North and South America, Europe, Africa, and Central Asia.

Andre has started and run four startups, in Brazil and the US, and was awarded Global Innovator of the Year in 2009 by World Bank’s infoDev. He has extensive experience supporting companies as mentor and consultant, both independently and as part of incubators such as 1776 and the Kosmos Innovation Center, and programs like Shell LIVEWire, StartUp Weekend and WeXchange.

As an economist, Andre has worked in topics ranging from innovation ecosystems, entrepreneurship and MSME development policy, competitiveness, business climate, infrastructure finance, monitoring and evaluation (M&E), and country assistance strategy for the World Bank, the Inter-American Development Bank (IDB), and the Brazilian Development Bank (BNDES). He has also consulted for clients such as DAI Global, the Economist Intelligence Unit (EIU), TechnoServe, among many others. He holds a master’s degree in economics from the University of London (UK) and an MBA from McGill University (Canada). Andre lives in the Washington, DC area.

He writes an awesome Blog called Entrepreneurship Compass and you can sign up here: https://entrepreneurshipcompass.com

DC “Networking Jackpot” – Big Idea CONNECTpreneur Fall Forum, September 13, Tysons Corner

LORE SYSTEMS is pleased to host our quarterly Big Idea CONNECTpreneur Forum, one of the most exciting angel and entrepreneurship networking forums in the DC Region on September 13, 2012 at the Tysons Corner Marriott.

InTheCapital called our June Forum “The Best Networking Event in DC.”

We also appreciate InTheCapital’s latest article on our upcoming Fall Forum: “Three Reasons Why You Should Attend the Big Idea CONNECTpreneur Forum.”

Please come out!  CLICK HERE to Register via the Eventbrite link.

The Big Idea CONNECTpreneur FALL Forum is a “NETWORKING MASHUP” of 210+ of the DC Region’s TOP Entrepreneurs, Business Leaders, CXOs, Angels, and VCs.  Most of the attendees are “INVITATION ONLY,” and we are limiting service provider participation in order to maximize the experience for our Attendees and Sponsors.

Presented by LORE Systems, this UNIQUE EVENT is like NONE OTHER in our region, due to the high quality of our attendees and participants, as well as our program and unprecedented networking.

Come see what happens when you put a group of “A List” business leaders and entrepreneurs in one room for a few hours!

Program Highlights:
  • Over 210 attendees, includng 120+ CEOs/Presidents and 40 angels/VCs
  • Conversation with CEO, VC Advisor, & Angel Investor Christopher M. Schroeder
  • Discussion with UBER Tech Entrepreneur David A. Steinberg
  • SHOWCASE of Emerging tech companies
  • NETWORKING sessions before, during, and after the event
The venue is the Tysons Corner MARRIOTT.  A plated breakfast and unlimited coffee are included.

FINAL AGENDA
7:00–8:00 am – ARRIVAL / NETWORKING
 
8:00 – 8:10 am – WELCOME
 
8:10 – 8:45 am – Conversation with Christopher Schroeder,
Renaissance Man, Entrepreneur, CEO, Advisor, Angel Investor, and Author
Author, Arab Inc(ubate)
Co-Founder and CEO, HealthCentral, formerly DrKoop.com (an InterActiveCorp company)
CEO, Washingtonpost.Newsweek Interactive
CEO, LEGI-SLATE
 
8:50 – 9:25 am  –  Conversation with David A. Steinberg,
UBER Tech and Marketing Entrepreneur
Chairman & CEO, CAIVIS Acquisition Corp.
Founder, Chairman & CEO, InPhonic / Simplexity (NASDAQ:INPC)
9:30 – 9:45 am – NETWORKING BREAK
9:50 – 11:15 am – COMPANY SHOWCASE
11:30 am – NETWORKING
CONFIRMED PARTICIPANTS (partial list):
Over 120 CEOs/Presidents, plus 40+ angel and VC investors including New Enterprise Associates, Novak Biddle, Core Capital, CIT, Blu Venture Investors, Blue Water Capital, Dingman Center Angels, Neuberger & Co. Ventures, Saratoga Investment Corp., Washington DC Archangels, Angel Venture Forum, Fortify.vc, Endeavor DC, Maryland Venture Fund, National Capital Companies, Enhanced Capital, White Hall Capital,  MTECH Ventures, Mosaic Capital, Opus8, VentureCross Partners, McLean Capital, Starise Ventures, Blue Heron Capital, Duncaster Investments, Private Capital Network, Next-Stage Development Group, Berman Enterprises, Grindstone Partners, Next Stage Development Group, Atlantic Capital Group, Lancaster Angel Network, Harrell Partners, Stanford Venture Advisors, MD Center for Entrepreneurship, Skada Capital, Great Falls Capital, Bayberry Capital, Hafezi Capital, Keiretsu Forum, and CADRE.
EVENT SPONSORS:  
 
LORE Systems
BDO
Wilson Sonsini
Deloitte.
Cooley LLP
Meltzer Group
AH&T Insurance
McBride Real Estate
Ryan & Wetmore
Washington, DC Archangels
Dingman Center for Entrepreneurship
Angel Venture Forum
Print 1 Printing

Happy Holidays, especially to our Troops!

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We extend our Best Wishes for a happy Holiday Season and a New Year
filled with Peace, Joy, and Success.
May we always remember our service men and women who sacrifice
for our well being and freedom.
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I wanted to share with you Lore Systems‘ 2011 Holiday Card.

2011 was a great year for Lore, for my family, and for me personally.

We have much to be grateful for as we look to the New Year.

Most of all, we must thank the brave men and women who serve our great nation. Thousands of them will be away from their families this December, and we want them to know that our thoughts and prayers are with them as they work to insure that we keep living the lives we choose to live.

Wishing you and your families a happy Holiday Season, and a prosperous and happy New Year!

May 2012 be your best year ever.

Tien

Winning Advice for Aspiring Entrepreneurs – Part 2

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As an evangelist of entrepreneurship and entrepreneurship education, I speak often to groups of students and entrepreneurs.  The last slide in my presentation is always “Advice for Aspiring Entrepreneurs.”  In my Winning Advice for Aspiring Entrepreneurs – Part 1 Blog Post, I discussed the first 5 of 9 pieces of advice I give to audiences whom I address. They are:

Integrity

Do It Now

Great People

Focus on Your Customer

Be Flexible

Here are the final 4 bullets:

Build a Culture EarlyI believe that the Right Culture is one of the 5 keys to building a Hypergrowth company.  And it’s never too early to build the right culture.  The minute you hire employee #1, you have doubled your company headcount.  Your startup is a reflection of you, your values, and your vision.  In order to get your team focused on the mission and how to execute, you need to make sure they all subscribe to YOUR values and vision, i.e. your culture.  Write your mission, vision, and values down, and communicate these constantly, in company meetings, emails, memos, etc.  Give frequent recognition and praise to those who embody aspects of your culture.  If you can have your teammates all living the same culture, you will have a huge competitive advantage over other companies in your space.

Be Persistent – Even the “best” startups fail.  And I bet most fail because the Founder gave up too soon.  It may take you 5 years or more to get to breakeven, so go into your venture knowing that succes will not come easily.  It takes energy, time, effort, sweat, and a little luck.  But if you hang in there and persist, you will get some breaks along the way and you will start to grow.  My company, CyberRep, took 4 years to hit $500k in revenue.  It was a long slog to get to that number.  Countless all-nighters, 85-hour workweeks, and sacrifice.  But we persisted, and by being in business and hanging in there, we started to get some breaks and we leveraged those breaks into little wins.  Then the little wins became bigger and bigger wins.  If we had given up early, we’d have never grown our company to $80 million.

Overcapitalize – When raising money, it’s very important to raise a little more than you need. I have seen so many entrepreneurs spend all their time in capital raise mode, when they should be spending time with their customers and building their team.  Raising money is a big distraction, so you need to make sure you have enough cash to get you to your destination instead of filling up many times along the way.  It’s OK to give up more equity because your payback will be in terms of time saved (and invested with your customers and team) as well as the fact that you’ll reach your destination sooner. This is one of my points in a prior Blog Post about Raising Money.

Have FUN!This is the most important piece of advice.  Life is short, and it flies by quickly….so if you’re not doing something you love, you are basically wasting your time. You have the power to change your situation, and the sooner, the better!  If you’re going to do anything, including starting a business, make sure you enjoy it. Sure, there will be many bad days filled with stress and disappointments, but success is all about doing your best and enjoying the ride.

Thanks very much for reading.  What do you think?  I’d love your feedback and thoughts, so please Comment below…and please sign up for my Blog too!  (See the Signup box on the sidebar of my Home Page)

Featured image courtesy of Robert Scoble licensed via creative commons.