If you’re used to taking equity investments, you might not think about borrowing money. Smaller companies with shorter operating histories may think they don’t even qualify for debt investment (which may or may not be true).
There are several good reasons to consider taking debt investments, though. The first reason is cost: debt sits higher in the capital structure and usually bears a lower rate of return than equity. The “rate of return” on a debt instrument is interest. Interest rates vary widely, depending on the credit worthiness of the company and the lender’s cost of capital. But interest rates are typically significantly lower than preferred dividends on equity. So, debt can cost you less than equity in the long run.
Another reason to consider debt is quick access to additional capital. Lenders — especially alternative finance companies — may be able to provide more money in a shorter timeframe. They can be there for you when you need them, and sometimes at a lower transactional cost than conducting another round of equity financing.
Finally, debt is treated differently for accounting purposes. You might find it useful to have debt on your books and pay interest expenses rather than dividends on equity.
The debt approach is not risk-free, however. We’ll discuss this in our next post.
Susan Alker is a California attorney with over 20 years of experience advising lenders and commercial borrowers.