Raising capital is one of the biggest challenges start-ups, as well as smaller businesses looking to expand, face. While debt in the form of bank loans was the mainstay for the larger part of the last century, the meteoric rise of private equity over the last few decades has increased the options available to businesses.
Australian entrepreneur, investor and maverick, Darren Herft thinks that both options look promising, depending upon the needs of any company.
“Debt sourced from traditional banking is essentially a liability on the balance sheets.”
According to Darren Herft, firms seeking future rounds of financing may find investors apprehensive in backing a company teeming with liability on its books.
He thinks that start-ups founders and company leaders should know that if their firm holds liability in the form of debt, they immediately fall behind a layer of stakeholders, their debt providers.
“If there is a merger or liquidation of the firm in question, the debt providers will be the first ones to get paid,” says Darren Herft.
Darren Herft believes that businesses must understand that debt accrued from traditional sources acts much like a hefty mortgage, they will invariably need to make regular payments to their lender(s),” cautions Darren Herft.
Such a cash drain can be a severe impediment for new firms that require as much liquid capital they can amass to reinvest in themselves to grow.
Debt is not all bad in Herft’s book and there are some advantages.
“Once the debt is paid off, the firm retains the same amount of equity in its business as it did when it acquired the debt,” says Herft.
Debt comes with a largely streamlined process and companies might find it easier to find investors willing to loan them a sum of money as debt as it entails lesser liability on their part.
He thinks that for those able to overcome the emotional hurdle of doing so, giving up part of their ownership might translate into owning a part of a successful venture.
It’s not all roses and rainbows, “Due to increased government scrutiny as well as the higher risk undertaken by investors, private equity carries the burden of additional paperwork.”
There are additional costs associated with obtaining equity funds such as company valuations and multiple onerous procedures that are typically time consuming.
“While a start-up or firm must disclose its equity holders when trying to secure additional funding, equity isn’t represented as a liability on a company’s balance sheets,” says Herft.
Firms also do not need to make regular payments to their equity holders and the capital thus saved can be reinvested into the business. Herft believes this gives ventures looking at aggressive expansion and faster growth a competitive edge.
“There is no hard-and-fast rule in business, a firm can also choose to go for a mix of debt and equity if that is what’s most advantageous for its goals,” says Herft.