What's It Worth?

Silver Linings

Despite the seemingly prohibitive cost of loan-guarantee financing, there's a compelling benefit that makes it hard to dismiss, especially for early-stage companies: By using guarantees to get a loan from a bank, a company can avoid surrendering any ownership in the company if they surrender revenue.

"When companies need capital very early in their development, equity investors must take a disproportionately large piece of the company to justify the risk they're taking," says Lipper. The net effect is that an entrepreneur can be left with little more than a grub stake before he or she even gets out of the starting gate. By contrast, a loan, even a very expensive one, leaves the founder with 100 percent of the company, a feat which presumably will motivate him or her to work even harder to make the venture a success.

Another benefit is that it may be easier to get an investor to guarantee a loan than to buy equity. Whereas the latter requires the investor to cut a very large check and put all his or her money at risk, a guarantee only requires him or her to deposit securities into the bank issuing the letter of credit. The common stocks or bonds the investor uses to collateralize the letter of credit are not impaired in any way and continue to work for the investor, hopefully growing in value. In essence, the investor is simply leveraging his or her assets.

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This article was originally published in the May 1998 print edition of Entrepreneur with the headline: What's It Worth?.

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