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Is it best to take on debt financing or equity financing in an unstable economy?

Answers

Topic Expert
Ken Kaufman
Title: CFO
Company: Community Dental Partners
LinkedIn Profile
(CFO, Community Dental Partners) |

I hate to start an answer like this, but without more information I would have to say it depends. The economy is less of an issue, working off of the assumption that the company is able to continue to solve customers' needs for far less cost than the value that comes from solving the need.

Debt is cheaper than it has been in a long time, making it more attractive. Depending on the level of personal guarantees and collateral required, debt should not be shunned in tough economic times.

Equity is getting more expensive, primarily because valuations are still down. Some reports show they are still going to drop.

In general, debt is much cheaper relative to debt, but more information would help me better answer the question.

Michael Jameson
Title: VP Finance
Company: Undisclosed
(VP Finance, Undisclosed) |

While I completely agree with Ken, there are some other considerations as well. First, equity holders can't call their debt. That is, they won't drag you into Chapter 7/11. In fact, the fact that they are in the boat with you sometimes leads them to being on the hook for more. Of course they may wash you out in the process (through ruinous valuations, etc.) but at least they have real skin in the game.

Second, although debt is cheap, it's also dard difficult to get to. Lenders are looking harder at everything these days. That not only delays the process, but it is leading to a lot more "no"'s than in recent memory. So despite the attractiveness of debt from a cost of capital standpoint, you may simply not be able to get there.

Third, banks finance cash flow, not ventures. Even venture debt is highly risk averse and typically will only follow well-established capital in the door. So if you are an early-stage company you will find debt really hard to come by.

So, to Ken's point, you would need to say a bit more about the specifics to get better advice.

Topic Expert
Ken Kaufman
Title: CFO
Company: Community Dental Partners
LinkedIn Profile
(CFO, Community Dental Partners) |

Michael makes some great points here, and fleshes out some additional things to consider. He reminded me of an article I wrote for American Express OPEN Forum called "Which is Better for Your Business: Debt or Equity?"

The article breaks down companies at different stages of their life cycles and defines which type of financing is preferred in each. You can read it here: http://www.openforum.com/idea-hub/topics/money/article/which-is-better-for-your-business-debt-or-equity-ken-kaufman

Best of luck, and feel free to pass along more specifics so we can have a more informed discussion.

Ken K.

subraramanyam P
Title: consultant
Company: retired
(consultant , retired) |

Thanks a lot for the link...
I would also like to give you a link www.changethis.com of Tom peters

Topic Expert
Marc Schwartz
Title: Partner
Company: Schwartz International
(Partner, Schwartz International) |

I just wanted to add a point or two if you're in an international/global group. One issue to consider is withholding tax (either U.S. or foreign withholding taxes on interest/dividend payments) and ensuring your interest expense is deductible. For instance, if you're in a tax loss position, you receive no current year benefit for the deduction. There are also rules for accrued but unpaid interest to related parties. Dividends from U.S. companies are often not subject to withholding depending on tax treaties. Finally, many jurisdictions, including the U.S., have thin capitalization rules that also impact the benefit of using debt versus equity.

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