2018-02-27 14:03:06 Funding and Financing English Learn the difference between equity and debt investments and the pros and cons of each investment type. Understand how to choose the best... https://quickbooks.intuit.com/ca/resources/ca_qrc/uploads/2018/02/Accountant-Explaining-Equity-Debt-Investments.jpg https://quickbooks.intuit.com/ca/resources/funding-financing/equity-debt-investments-businesses/ Do Equity Investments or Debt Investments Work Best When Starting Your Businesses?

Do Equity Investments or Debt Investments Work Best When Starting Your Businesses?

4 min read

If you’re currently running a Canadian small business, you might be operating at thin margins or have other issues that are slowing your growth. Fresh investments in your company can kick start an expansion phase that takes your business to the next level and leaves you much better off than you were before. But what kind of investment should you bee looking for? Are you interested in selling pieces of your company for cash up front, or do you think it’s a better idea to take on some debt in the here-and-now, and then pay it back with your new profits? Knowing your options here, before you start soliciting investors, can ensure your company grows the way you want it to by helping you raise funds in the way that best fits it.

Types of Equity Investments

You have a range of equity investments to choose from that each offer their own advantages and disadvantages, but they come in two basic types: debt and equity. Debt financing is, basically, taking out a loan. You can do this by either going to the bank and getting a traditional business loan, or by selling bonds. Bonds are really just a promise to pay back — plus interest, of course — the money you’re borrowing now. Your credit card is essentially a bond American Express bought from you. Your bank account is also effectively a bond you’ve bought from the bank: you give them money right now, and the bank promises you can take it out when you want, plus interest if you got a good deal.

Stocks are different. With stocks, you’re not borrowing anything; you’re selling something. In this case, what you’re selling is a share in the company you control. Buyers become limited partners in your business and can (sometimes) vote on how you do things with their money. They can also take a share of the profit going forward, and in some cases they can sell their share as if it was a physical object.

Pros and Cons of Equity Investments

If you want to grow profit quickly, equity investments might be the best choice for your business, as they usually offer higher return rates long-term. This increased potential for profit also comes with a downside: equity investments typically have more risk attached, making it easier for inexperienced investors to lose money. For instance, if the companies you buy stock in fail to grow and provide dividends or fall lower in price, you can lose big chunks of your investment quickly. You can, however, mitigate this risk by investing in consistently high performers, though price per share costs might mean buying fewer shares at the outset. Mutual funds even out this risk with professional managers diversifying investments within those funds to avoid putting all their clients’ eggs into a single basket, and they typically run lower risks than buying stocks outright, but they don’t typically offer as high a return as carefully tended stock purchases.

Real estate purchases tend to hold their value over time as property values in many places continue to rise. With the right tenants in commercial buildings and residential homes, you can achieve a nice level of monthly profit, but the wrong tenants have the potential to cost you much in the way of property damage, lost rent, and eviction costs. REITS typically get around this problem by using property management companies to handle rental issues, but if these concerns buy up lots of homes or buildings in an area are hit by a natural disaster, it can drive the value of even stable investments down. Also, both real estate and REIT investors can run into problems by buying problematic properties that cost more to repair or remodel than they’re worth.

Types of Debt Investments

Debt investments include a group of stable offerings, often from financial institutions, that offer set return rates in exchange for lending them your money. Some debt-based investments include savings accounts that provide you with interest payments monthly based on the amount of money held in your account. Certificates of deposit, or CDs, offer the same percentage-based deal, but you must leave a set amount in your account for a certain time period, whereas you can draw money out of your savings account at any time and still receive previous months interest payments.

Corporate, government, and municipal bonds are essentially IOUs issued to lenders that provide a set amount upon their maturity. These encompass a wide array of financial instruments, including those with guaranteed set value even if the original issuer fails to pay and speculative types that often have cheaper prices and chances of bigger payouts due to their risky nature. With annuities, you pay into these financial instruments during the accumulation phase with the agreement that the company pays you back more later during the annuitization phase. These can include pension plans and retirement accounts, and they provide stable, reliable income over a time period you arrange.

Pros and Cons of Debt Investments

While debt investments tend to have lower risks attached, this means they also typically have lower return rates. Plus, if the organization, individual, or business you invest in fails to thrive, you can sometimes lose your total investment if they file bankruptcy. Another disadvantage of investing in debt is inflation, as many of these instruments don’t provide a return rate that keeps up with monetary inflation rates. This means that holding debt investments can actually lower your capital rather than increasing it. Downsides for annuities include a lack of liquidity, meaning you can’t trade them in for big chunks of cash without incurring penalties.

When considering investments for your small business, first analyse your current needs to figure out potential future needs, and then choose your investments accordingly. As with mutual funds, the best approach is often diversifying, creating a hybrid investment profile that includes riskier equity investments balanced by slow and steady debt investments.

Information may be abridged and therefore incomplete. This document/information does not constitute, and should not be considered a substitute for, legal or financial advice. Each financial situation is different, the advice provided is intended to be general. Please contact your financial or legal advisors for information specific to your situation.

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