To Borrow or Not to Borrow
(YoungBiz.com) - Cash, moolah, dough, greenbacks--everyone needs it, especially a first-time entrepreneur. You could have a great idea, a thorough business plan and customers just waiting for you to open your doors, but if you don't have the funds, you can't get your business off the ground.
So what's a 'trep to do? Unless you want to raise the money yourself through part-time jobs, yard sales and the like, there are basically two ways to finance a new business: debt financing, usually through a loan or credit card, and equity financing, in which investors buy "stock" in your company. Both have pros and cons, as 'treps Angeil Brown and Dan Villa recently found out.
A couple years ago, Brown, now 20, of Houston, turned her picture-taking talents into a business and even involved some of her classmates. Unfortunately, photography businesses have a lot of start-up costs. Cameras, film and developing equipment don't come cheap. With no established credit history, a bank loan was out of the question.
One of their teachers suggested Brown and her classmates offer shares of the business to friends, parents and teachers for a whopping $1 per share. They soon raised between $200 and $300 in capital. Sound too good to be true? Well, there was one catch. In return for their $1, investors would evenly split 10 percent of any profit the company made. They may have given up a bit of their company, but Brown feels it was the right decision.
"It's a win-win situation," she explains. "As business owners, we are able to cover our expenses, and, at the same time, our investors make money when the company profits."
Villa, 19, on the other hand, chose debt financing when he started Pintlar Delivery Service in his hometown of Anaconda, Montana, through a loan from the Anaconda Local Development Corporation (ALDC).
"The ALDC contacted the teacher in charge of the School to Work program and said they were willing to give a loan for a youth business," Villa remembers. He was chosen from the field of five, and the organization quickly approved his business idea (their only condition for the loan). He then provided the ALDC with an estimate of his start-up and operating costs, and was soon given the $500 he needed.
While Brown gave up a portion of her profits to her investors, Villa makes a loan payment each month--with interest. Like Brown, however, he's convinced the decision was right for his company.
So What's the
Because every business is different, there's no one right answer. Before you make your decision, take a closer look at the pros and cons of both equity and debt financing:
- Paying back a loan or using a credit card responsibly can be the start of a good credit history, something you'll need in the future when you want to buy a car or a house. "This helps me establish credit," Villa explains of his ALDC loan.
- With equity financing, you don't have to make loan payments.
- Villa believes that making the monthly payments on his loan helps build character. "I really think the payments make you a more responsible person," he says.
- With a loan, the money is available as soon as you're approved and the papers are signed. A credit card is there whenever you need it, as long as you don't exceed your limit.
- While Brown's investors could potentially have a say in how her business is run, banks and credit card companies leave the management up to you as long as you pay them on time.
- Interest rates, according to Villa, are the deciding factor on whether he would choose to get a loan again. "The only reason I wouldn't want a loan is if the interest rate was too high--you'd end up paying that back for years." Credit-card rates vary, so it pays to do a little research. Also, don't be afraid to ask if there is a lower interest rate available. The first rate you're offered often is not the best rate the company has available.
- With equity financing, you give up partial ownership of your company to your investors. This could mean giving up partial control of your decision-making process as well.
- The approval process for a loan, or getting a company to issue you a credit card, can be a daunting task that could require your parents' help.
- Just as a loan or a credit card can provide you with a favorable credit report, it can also do just the opposite if payments aren't made in full and on time. And, just to add to the fear factor, many loans require collateral, something of value you tell the bank you'll give them if you default on the loan. Like your car. Yikes!
- You've got to be cautious, or you can get in over your head. Remember, credit card companies make money off of the interest you pay on the money you borrow, so the more money you borrow and the longer you take to pay it back, the more money they make. Good new for them; very bad news for you.
A couple words to the wise: Know how long it will take for you to pay off the money you've borrowed. While a bank loan is typically paid back over a designated period of months or years, credit cards operate on "monthly minimums"--and payments of only the monthly minimum can drag on for many, many years. If you borrow off of a credit card, draw up a payment schedule for yourself if you need to, based on the interest rate and the monthly amount you can afford. An interest rate calculator, such as the one at http://www.interestratecalculator.com, can help you to do that.
Also, if you feel a credit card company has extended you more credit than you feel you can afford to borrow, ask them to cap your credit at a certain level. Otherwise, they will automatically raise your credit limit periodically, as long as you're in good standing. And you might be tempted to spend those extra bucks on nonessentials.
Villa believes that credit can be a good thing and that everyone may initially make some mistakes. The key, they say, is to do extensive research and honestly assess what amount you can repay on a monthly basis. If you do all this, a bank may just end up giving you a little credit.
For reprints and licensing questions, click here.