| Debt Capital, Equity Capital & Convertible Debt | | | | investors are willing to give you capital but will play |
| There are three basic types of funding options for | | | | little or no part in running the company, while active |
| mid market companies: debt, equity and convertible | | | | investors expect to be heavily involved in the |
| debt. In this article, we will discuss the trade offs of | | | | company's operations. Investing in a company's equity |
| each of these funding options in the context of a | | | | over a long term without any security collateral is |
| mid-market company. | | | | inherently high risk. As a result of that, this form of |
| Debt capital is money raised for a company that | | | | capital typically comes with an active participation |
| must be repaid over a period of time with interest. | | | | from the investors. |
| Debt financing can be either short-term or long-term. | | | | Passive or active, equity investors are typically |
| Unsecured debt is rare and lenders typically secure | | | | patient, long term investors. These investors seek to |
| debt with assets of the company. This also means | | | | add value in an effort to help the company grow and |
| that service, technology, and other asset-lite | | | | achieve a greater return on the investment. In return |
| companies have a hard time raising debt capital. | | | | for their risk and participation, private equity investors |
| Common debt financers include banks, credit unions, | | | | usually look for a 25% or more return on investment, |
| finance companies, and credit card companies. | | | | and put a number of checks and balances on the |
| Advantages of debt capital | | | | company's operations to achieve their goals. |
| - Raising debt capital, for profitable asset intensive | | | | Advantage of Equity Capital |
| companies, can be faster than raising equity capital. | | | | - Lack of recurring principle/interest payments makes |
| - Debt capital is typically cheaper than equity capital | | | | the business more able to cope with the ebb and |
| because the financing companies pick only the lowest | | | | flow of the business and increases the margin of |
| credit risk companies and further secure their loan | | | | safety |
| with assets. | | | | - Corporation's risk is shared with investors |
| - The lender does not gain an ownership interest in | | | | - Right investors can add significant value |
| the business and this allows the business owner to | | | | - Smooth transition option for business owners |
| remain in the driver's seat of the company without | | | | looking to ease out of the business |
| being answerable to investors. | | | | - May be the only possible type of capital for rapidly |
| Disadvantages of debt capital | | | | growing and asset-lite companies |
| - The loan amount and the interest payments can | | | | - Equity investor is committed to the company until |
| saddle the balance sheet and income statement of | | | | exit. If the company gets into trouble, the equity |
| the company. | | | | investor is likely to help with the turnaround |
| - Any downturn in the business or unexpected capital | | | | Disadvantages of Equity Capital |
| needs can make it difficult to make the interest | | | | - Owner answerable to investors and some loss of |
| payments and send the company into a debt induced | | | | control |
| downward spiral. | | | | - Can be more expensive than debt capital (albeit at |
| - For some debt instruments, the terms can be | | | | a lower risk) |
| complex and may onerously burden the business. | | | | - It typically takes longer to raise equity capital than |
| - If the debt is personally guaranteed, liability will | | | | debt capital |
| extend to non-business assets. | | | | - Deal terms can be complex. Without good deal |
| - If the company gets into trouble, the debt financier | | | | making support, the company may unknowingly allow |
| could become adversarial. | | | | the investor to undervalue the company and take a |
| Equity Capital | | | | disproportionately higher percentage of the company |
| Equity capital is money raised by a business in | | | | compared to the value of the investment made. |
| exchange for a share of ownership in the company. | | | | Convertible Debt |
| Equity financing allows a business to obtain funds | | | | Convertible debt is a hybrid of debt capital and equity |
| without incurring debt and without having the burden | | | | capital. Convertible debt typically involves favorable |
| of associated interest/principal payments. For a | | | | interest rates and other terms on the loan in return |
| growing company with cash needs and for companies | | | | for the option to convert some or all of the debt |
| with an erratic earnings stream, it can be a big | | | | into equity at predetermined price levels. Convertible |
| advantage to not have to repay a specific amount | | | | debt instruments are complex and require a |
| of money at a particular time. | | | | substantial amount of work on the part of the deal |
| Equity capital can be public or private. Public equity | | | | makers. There are many different variations of |
| capital is only available for large companies (revenues | | | | convertible debt available depending on the needed |
| over a hundred million dollars). Two key sources of | | | | trade-off between debt and equity. |
| private equity capital for mid market businesses are | | | | Convertible debt is more likely to be seen in |
| Private Equity Groups (PEGs) and corporate investors. | | | | distressed or high risk companies, and some investors |
| Other forms of private capital such as angel capital | | | | specialize in distressed convertible debt. However, the |
| and venture capital, are typically not available to | | | | flexibility of convertible debt makes it an attractive |
| mid-market companies. Angel investors and venture | | | | option in a wide variety of situations. This option |
| capitalists provide funding to young, nascent private | | | | gives the management maximum flexibility and is |
| companies. | | | | worth considering for larger mid-market companies. |
| Equity investors can be passive or active. Passive | | | | |