Typically involving a bank or a private investor, a debt arrangement includes an exchange of cash with a set maturity date and interest rate. These banks or lenders will typically request a duration between three and ten years at an interest rate significantly above the prime rate to account for the implied risk of the investment. Working with our business plan consultants will ensure you attract the lowest rate possible because we will connect you with our preferred lenders and help facilitate the process.
No ownership interest is transferred over to the lenders; however some or all of the owner’s tangible assets may be pledged as collateral. In the event the business defaults, the lenders will rightly claim these tangible assets. Debt financing is a more common solution for raising capital but, as our business plan consultants discuss in our blog, there are several hurdles to overcome. The Corporate Finance Institute provides rich commentary on the complete debt financing process, highlighting the process, pros, and cons.
Conventional banks do not participate in private equity deals. Equity funding will come from private investors or specialty investment firms. These firms will seek out a share of net proceeds, likely in perpetuity. As part of our comprehensive service, our expert business plan consultants can help with deal structuring to ensure an equitable agreement.
As part of this type of agreement, the investor assumes a stake in the company, proportional to the amount contributed relative to the amount the owner provides. Rather than a fixed monthly payment paid out, the investor receives a percentage of the distributable free cash flow commensurate with his percent ownership stake in the company.
For owners willing to concede a portion of the company, equity funding is an attractive approach since it’s a smooth process and can be implemented very quickly. However, in general, owners will lose some autonomy in decision-making. Depending on the investor, this might be fine.
Another efficient funding source is entering into an agreement with a private investor whereby he is contractually obligated to a percentage of annual sales. The investor hands over the cash requested by the business owner. Revenue sharing does not involve any equity transfer and so the investor has no stake in the company.
If the business outperforms expectations the investor will be in a position to capitalize on his investment. It’s likely that the revenue sharing model will continue in perpetuity. Working with expert business plan consultants can help you value out the business and determine the optimal percentage to offer to investors.