Cash for Equity Can Cost You so Much More in the Long Run
Offering key players, such as developers, marketing directors and executives, equity instead of cash has been a long-running tactic that entrepreneurs have embraced over the years. When you offer equity in your company, investors contribute cash, expertise or both for ownership in your company. It's an ideal tradeoff: you get to take advantage of leveraging cash for your business and saving on doling out a steady paycheck to employees, contractors or other stakeholders while swapping it for a stake in your company. But you may be paying more than what you bargained for in the long run. Here's why:
Your Equity Value Will Shrink
The more investors that get equity in your company, the more you minimize the value of the equity you already own. That's because investors will likely negotiate the valuation lower than what you may value it at or negotiate a higher equity stake. Moreover, the more investors you get involved the more equity you may have to give up. Thus, it's important to do the math and minimize your risk of thinning out your ownership in your company. Also, make sure you're not giving away too much equity in hopes of getting as much funding you can get as soon as possible.
You'll Have to Buy Out Your Partner if You Want to Own Your Business
While equity financing doesn't obligate you to repay, you don't own your business outright after you finish repaying the loan when you opt for cash and trade equity in your company. Bringing in venture capital infusions or a partner with cash means that you can never pay off your debt until you sell. Moreover, if you distribute preferred stock options to these investors, they'll receive payment first if you sell the company. This would dilute your ownership in the company and you may be paid less on the sale of your company. The only way to pay off what you owe would be the route of buying out your partner.
You May Lose Control Over Your Company
When you choose equity to finance your business, you may risk losing or minimizing your control over the company, depending on how much equity investors have in your business. This means that it may be harder to make important business decisions or push projects through when you have a board of investors to answer to.
More Success Means More Equity
But the more successful your business is, the more equity cash can cost you. That's because often more money is required to allow the company to grow and operate efficiently. You can easily opt for more equity funding but that means more investors will be involved.
Complex Taxes May Be a Challenge
Equity financing doesn't make your taxes any easier to complete. Your business structure will impact how equity is distributed and determine if you can receive a reduction for compensation on your income taxes. For instance, LLCs often face the challenge of distributing equity to employees, and even the type of stock you select can impact your S Corporation status.
Supporting your company with equity is an ideal way to get it off the ground. But you have to ensure that equity financing is the best option for you and your business. Also, consider using a reputable bookkeeping company to handle the work. By leveraging professional experts for your finances, you can figure out if equity financing is right for your business over time.