There are several situations in which an equity fundraise makes the most sense, or is the only real option for a company. Internet companies, for example, are notorious for going years in operation without even attempting to charge their customers. While home-growing your company from your kitchen or spare bedroom bit by bit may not sound as glamorous as hitting the ground with investors already in your lineup, most investors will expect you to start there before they invest.
But some businesses—a private jet service, for example— require a massive amount of capital just to get off the ground. In those cases, you have little choice but to go directly to equity. Equity capital tends to follow businesses and industries that have potential for massive growth and exponential paydays. Equity narrows your options: Choosing the equity route significantly narrows your options when it comes to the future of your company. Equity investors are interested in one thing: liquidity. Before they invest in the first place, they are going to look for assurances that your idea can sell and sell big, and that that is your plan, so before you pursue the equity fundraising route, you should be sure that that is your vision as well.
Equity investors expect big rewards for big risks : If every entrepreneur could walk into a bank and get a loan to finance their idea, many probably would.
Sound Mind Investing
Unfortunately, banks are incredibly risk-averse, and only want to provide loans that they are sure will be paid back. Competition for equity investments is high: There are far more people looking for equity investors than there are checks being written. Most equity investors will see hundreds if not thousands of deals in a given year before they fund even one. Getting an equity investor is like getting a perfect score on your SATs: you have to be in the top percentile of the top percentile of the most prepared and motivated entrepreneurs in order to be one of the few that walks away with a check in hand.
So if you and your business are in a time crunch, equity fundraising may not be the best way to go. Loan or debt-based fundraising is the easiest of the three varieties to understand in basics: you borrow money now and pay it back later, with an established rate of interest. Debt is also the most common form of outside capital for new businesses. When you decide to pursue debt-based fundraising, you specify in your fundraise terms the rate of interest that will come with the repayment of the loans you receive.
You may also provide an expected time frame in which the loans will be repaid. The more collateral you have, the better your chances of securing large amounts of financing. As collateral for these loans, Rusty offers the cars themselves, as well as mortgage on the property for the dealership, which he already owns.
As with equity, there are a handful of scenarios where debt is the most useful option for financing your company. Debt raises lend themselves well to smaller amounts of capital. Debt raises tend to move along faster, giving you a better shot at getting you the funds you need when you need them. If your funding needs are in the physical realm—you just need real estate, for example, or computers or other equipment— a debt raise makes a lot of sense. Many entrepreneurs are understandably reluctant to give up equity in their company, and a straightforward debt raise has the attractive benefit of allowing you to retain ownership and control of your company.
Small Business Association. In this case, our wildly indebted yet somehow solvent government plays cosigner to your loan.
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Uncle Sam is a bit tight-fisted, because he has a lot of checks to hand out; but he may be the only uncle that is willing to bet on your new idea right now. Credit is comparable : In some cases, you can achieve the same goals with credit as you can with loans, since the upper limits of both tend to be about the same for business users. American Express, for example, offers both a day charge card with a floating limit and a more traditional credit card that offers flexible monthly payment options. Going with credit has the advantage that the decision is much faster compared with the lengthy loan application process.
Convertible debt is essentially a mash-up of debt and equity: you borrow money from investors with the understanding that the loan will either be repaid or turned into a share in the company at some later point in time—after an additional round of fundraising, for instance, or once the business reaches a certain valuation.
The specifics of how the debt will be converted into equity are established at the time of the initial loan. A traditional bond is an instrument that gives the holder a stream of cash flow coupons over a period of time. When inflation increases, interest rates tend to rise as well. This negatively impacts the present value of those future cash flows. Simply put, if rates rise across the credit curve, investors may begin to demand higher rates of return or lower prices for bonds being traded.
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Additionally, if inflation is on the rise, the future coupon payment of a bond will buy less goods and services than it would today. Fixed income instruments have a wide range of maturities, and inflation impacts these bonds differently. As inflation and rates rise, short-term bonds i.
How Do Bonds Work?
Holders of short-term bonds receive their coupons sooner and are able to reinvest quickly at potentially higher rates of interest. The credit quality of a bond is also a key consideration. Performance varies when comparing U. Treasury securities, with higher credit ratings, to corporate bonds, with lower credit ratings.
If the economy is perceived to be healthy during an inflationary period, markets will favor bonds with lower credit ratings since they come with a higher coupon rate than U. On the other hand, if the market feels the economy is not on good footing, markets will favor bonds with a higher credit rating, such as U. High-yield bonds offer higher coupons and yields relative to investment-grade bonds.
Investors accept the increased credit risk of high yield bonds in exchange for a higher yield. The value of high-yield bonds is impacted by many economic factors in addition to interest rates and inflation. Their higher coupon rates cushion the bondholder by offsetting some of the effects of rising rates. This has been the case in environments where rates rise slowly and the economy is sound. However, it is important to understand that high yield bonds carry credit risk, and their values are highly correlated with stock values, making them more volatile than investment-grade bonds in times of economic turmoil.
As inflation rises, so does the par value of the security. TIPS bonds carry extremely low credit risk as they are issued and backed by the U. However, they do carry almost direct exposure to inflation risk. If inflation slows, the par value of the bond will be reduced.
Please reference the following example:. Floating-rate bonds are another option to combat inflation and rising rates since their coupon increases in conjunction with the U. These instruments usually carry a maturity in the two to five year range, and are issued by institutions and governments. Rising rates that often accompany inflation would cause floating-rate bonds to outperform most other fixed-income instruments.
However, it is important to note that these bonds do carry credit risk, and periods of economic turmoil may cause them to lose value, perhaps sharply. Retirement plan participants typically are typically exposed to these instruments in small allocations within bond mutual funds that encompass many sectors of the fixed-income universe.
Inflation is one of many economic factors that impacts the value and performance of retirement savings. Equities tend to withstand an inflationary period better than most sectors of the bond market. The timing and consistency of cash flows from equity and bond investments are key considerations in determining how sensitive an investment is to inflation and rising rates.