As Robert pointed out correctly, there are pros & cons
to both deal structures.
While a loan is typically more secure and less rewarding
from an investor’s point of view, an equity investment generally reflects a
higher risk and bigger financial return, if the venture turns out to be a
Since you’re indicating in your post that you will be
purchasing an existing woodworking business for $450,000, I am assuming that
you have done your due diligence, reviewed financial statements of the business
(both historical and pro forma), and perhaps even did a formal valuation of the
business. If you didn’t, doing so will be essential to accurately assessing the
most suitable financing options.
For instance, if the business is flourishing and generating
relatively predictable cash flows, financing the deal with a loan is usually
the better option because it involves a lower cost of capital.
On the contrary, if the business is a potential turnaround
candidate and with no cash flow, a history of losses, or any other signs of
distress, an equity investment might be a more suitable alternative because an
investor (i) typically shares a portion of the risks, (ii) won’t tie up scarce
financial resources to service debt, and (iii) is probably in for the long run.
But remember he will also be there and ask for his share in the profits for as
long as he holds an ownership interest in the business. The latter typically
makes equity financing the most expensive form of financing there is.
Well, this sound pretty cut and dry, but it isn’t. Corporate
finance can become extremely complex and thus, there are equity and hybrid deal
structures that have more characteristics of debt financing transactions and
vice versa. So, it will be key that you do your homework or work with a
professional who helps you minimize risks and maximize deal benefits.
With that being said, there are also a number of risk
factors that come with acquiring an existing business versus acquiring just the
assets. This can have widespread implications and quite possibly even make you
liable for liabilities incurred by the previous owner. Be careful.
Please feel free to send me a PM if you have any more
questions or if you wish to discuss your options in greater detail.
very sound advice, so first of all thanks for your time
you brought up some good points about liabilites, i have been told that there is not any outstanding debt or any jobs incomplete, but of course that is no proof.
the business was founded in 1985 and bought by the current owner 2 1/2 years ago, he has problems ,no back ground in wood work at all. and the preivous owner promissed to help train him but didn`t . So the business has gone down hill for about 2 years, but still has enough cash flow to break even each month untill now it has shown a profit of about 10% of gross
Sounds like a great opportunity, but again, there are many
details to be looked into before you can make a sound decision. While it
appears that you have insights into the company’s financial situation, at least
to some degree, I’m not sure if they are based on what the owner told you or
whether the owner in fact supplied you with verifiable financial statements.
Gathering these statements should be part of your due diligence and become the
basis of your decision-making.
This will not only protect you against potential liabilities
(e.g. liabilities for income, sales, or payroll taxes after an audit), it will
also enable to select the most suitable framework to position the company for
If you think that the company’s current cash flow may be
sufficient and predictable enough to service the loan provided by your partner,
than that is in all likelihood the route to go. If your partner wants to have
some skin in the game, you can include incentives such as warrants to purchase
stock, profit sharing, and the like for as long as you maintain the key characteristics
of a loan.
Again, please feel free to send me a PM if you’re interested
in exploring your situation in greater detail. I hope this helps.