What's your company's best financing alternative?

• Author: Carroll, John R.
• Position: Private companies

Entrepreneurial companies continue to encounter challenges in financing growth as private capital markets remain volatile. However, both debt and equity capital remain available for high-quality, well-managed companies. By raising capital now, businesses can enhance their firms' long-term strategic prospects for funding innovation, upgrading human capital, expanding market share and pursuing strategic acquisitions.

Choosing Equity or Debt Financing

Even in a challenging market, deciding whether to seek debt or equity financing depends on a company's needs and overall strategy, rather than external market factors. In general, debt financing is less costly on an absolute basis than equity capital. Debt is not "permanent capital," as it must be repaid over time.

However, while the company takes on the fixed costs of interest and principal payments, stockholders do not give up significant equity ownership. Typically, the lender takes no management role unless the company violates its covenants or defaults on its payment obligations.

There are several different forms of debt. Bank debt, either term or revolving, is typically senior in right of payment and secured by company assets. This is generally the least expensive form, and usually requires principal amortization during the loan term with a final maturity within five years.

Although more costly, subordinated debt is usually structured so that borrowers pay only interest for the first few years, then repay all of the principal at maturity--five to seven years or longer from the original loan date.

Equity differs fundamentally from debt--it involves the exchange of permanent equity capital for ownership. While equity can be public or private, public equity offerings are infrequent in the current market environment. For a private equity transaction, investors will purchase either a minority or majority stake of the company. In either case, private equity investors typically require that the company grant them board representation and a voice in strategic decisions.

With growth equity--a subset of private equity--the investor typically takes a minority position, often uses little or no leverage and works collaboratively with the current management team in overseeing operations. It differs from venture capital by targeting established companies that are growing and already profitable, and differs from leveraged buyout financing in employing modest or no debt capital.

Growth equity partners may...