Real Life Question: My small business desperately needs marketing help but I can’t afford it. A marketer has offered to provide the services I need in exchange for shares in my company; should I do it?
It’s one of the Catch-22s of running a business: I need a killer website or advertising or marketing services to increase revenue but I need to increase revenue to afford the thing that will increase revenue.
Some entrepreneurs, not wanting to take on debt for something that is not guaranteed to make them money, consider giving up part of their company to get the services they need.
Funding your business in this manner is very tempting, especially when your needs are high but there are tumbleweeds in your business chequing account. Giving up some shares in order to get your business to the next level seems cheap, but is it really?
There are generally two ways to fund your business’ start-up or growth; debt and equity.
Everyone knows about debt- you get a loan from a family member, friend, credit union, bank, or loan shark and you have to pay it back on terms agreed between the two of you. Whether that money actually generates more revenue or not; you’re still on the hook to repay it.
Equity, on the other hand, allows you to sell part of your business in exchange for assets or services. If the assets or services don’t generate the expected results, there’s no money to pay back.
Many entrepreneurs look at the “what if it goes wrong” angle and try to avoid debt at all costs. While it is true that you don’t have to pay back money you receive as an investment if the company flounders, what happens if the investment actually pays off and your company starts to skyrocket? You have just very expensively funded your expansion as someone else now owns a piece of that much more valuable company.
Let’s say you need services that cost $30,000. You agree to give up 15% of your company in exchange for these services. The services work and your product lands on whatever today’s equivalent to Oprah is. Your phones start ringing off the hook and within a few years, your business is worth $1m. With the increased valuation, those services have now actually cost you $150,000- 15% of $1million. The business owner who took out a loan for the $30k to pay for the services has had to pay some interest, but he has far more of his $1million than you do.
Whether you decide to fund expansion by debt or equity is a complex question that should be decided after consultation with your advisors. However, there are a few points you should always bear in mind:
- How quickly do I want to grow? If you want to quickly grow a capital-intensive business, you may not be able to raise the fund you need with debt financing alone.
- What’s your exit plan? If you don’t intend to grow the business to sell it, giving up shares may not be a big deal because that valuation may not materialize.
- How willing are you to assume debt?
If you’re at a stage in your business where you need funds to grow but don’t know the best way to get those funds, let’s have a chat.