Equity vs. Debt Financing: How to Raise Money for Your Company
Money may or may not make the world go around but you will certainly need it to operate a business. Whether you are launching a startup or expanding an existing business, you can generally raise funds via either equity or debt financing.
“Equity” here, effectively is your ownership stake in your business. If you have incorporated a company, the shares in the company constitute the equity. Equity financing generally involves a company allotting shares to a third party in exchange for some consideration (usually money), which will constitute “capital” for the company.
The major benefit of equity financing is that there is no obligation to repay the money received. The capital can be utilized by the company for growth and development and the investor who provided the capital would hope to get a return, when the company makes a profit and declares dividends. The obvious downside is the diminished ownership stake of the existing shareholders. Additionally, investors rarely acquire equity with no strings attached. They will usually require the shareholders to sign a shareholders’ agreements which may put certain limitations on things the company may do. For instance, it may give the investor the right to appoint a director to the board. It may also stipulate that certain steps cannot be taken by the company without the investor’s consent, such as acquiring assets, paying salaries or taking on debt financing over a certain amount.
An allotment of shares, i.e. the issue of new shares, must be down in accordance with Articles of Incorporation for the company and the Companies Act. This includes the directors passing a resolution approving the allotment, the issue of the new share certificate and the update of the register of shareholders. A Return of Allotment indicating the number of shares, the details of the investor/new shareholder and the amount paid on each share is to be filed with the Companies Office of Jamaica within one month after the shares have been issued. Where shares are paid for in property or past services rendered, a contract in writing, duly stamped, evidencing the title of the investor to these shares should be executed and a Particulars of Contract also filed with the Companies Office. If shares are not paid for in money, such as where the investor may be contributing land or equipment as consideration, the directors before passing any resolution should obtain a valuation from a qualified accountant, valuer or surveyor, reporting that in its opinion the value of the “other consideration” in question is worth at least as much as the amount which will be credited as paid up on the shares to be allocated in respect of those services or that consideration.
When a company borrows money, this is debt financing. The clear downside is that company must repay this debt within a specified time along with interest. Failure to repay can have various implications. However, once the debt is repaid, the lender no longer has any involvement with the company, unlike an equity investor. The lender, via its loan agreement or other document will also seek to impose certain reporting requirements on the company as borrower and restrict the company from certain activities which may impact the company’s ability to repay.
Debt financing may be secured or unsecured. A debt is “secured” when the lender takes a charge over certain assets of the borrowing company, which it can realize/sell in the event of a failure by the company to repay the loan. Unsecured loans often attract higher interest rates and are often only given to well established companies assessed as having a low risk of default.
Secured Debt Financing
Lenders may look to charge various assets as the “collateral” or security for a loan. This may include, real estate, securities, money in a bank account, equipment and motor vehicles.
If the company owns real estate, the lender may have the company grant a mortgage that will be registered on the Certificate of Title for the land. The company would be free to utilize and operate on the land subject to the mortgage, however, the mortgage document will place certain obligations on the company. Obligations such as to keep the property in good repair and insured, to keep up to date with the payment of property tax and other charges and not to otherwise charge the land without the lender’s consent. A mortgage once issued must be stamped at the Stamp Office and then registered at the Titles Office if it is to constitute a legal charge, registered in accordance with the Registration of Titles Act. A form 16A Particulars of Charge must also be filed with the Companies Office of Jamaica.
Charges Over Personal Property
The Security Interests in Personal Property Act (the “Act”) applies to every transaction that in substance creates a security interest in personal property. Under the Act a “security interest” is an interest created contractually over personal property that secures the fulfilment of one or more present or future obligations. Lenders will often have non-possessory security interests, created by a written contract which must sufficiently describe the secured property and which will stipulate that the lender will not take possession of the personal property, unless the borrower is in default. The lender will therefore have the company execute the appropriate document, such as a collateral security agreement or debenture, over all the assets of the company or specified assets of the company.
Personal property includes goods, documents, financial instruments, accounts receivables, intellectual property and other kinds of intangibles. Receivables are amounts owed to a company and are regarded as assets. The Act defines an accounts receivable as “monetary obligations not evidenced by a financial instrument, whether or not those obligations are earned by performance”. Companies may also charge shares that it may own in other companies as security, or the shareholders in the company borrowing funds may be asked to charge their shares. Such charges will also fall within the purview of the Act, unless the shares constitute securities held in a central securities depository licensed under the Securities Act. Shares in listed companies may, however, also be the subject of charges and pledged via the Jamaica Central Securities Depository.
The document creating the security interest should be stamped, and a notice filed with the National Security Interests in Personal Property Registry, an electronic register of notices for the registration, amendment and termination of security interests in personal property. The filing of the notice establishes the priority rights to the collateral. Potential lenders will also carry out searches to determine whether an asset has already been charged to someone else.
Whenever a lender is taking security it will want to satisfy itself of the company’s ownership of the asset and will request copies of all relevant titles and certificates. The lender will also seek to satisfy itself of the value of the asset and may request a valuation report. The cost associated with this exercise as well as the creation of the loan and security documents will also often be passed on to the borrowing company.
Ultimately, most successful companies will need to have a mixture of equity and debt financing. Whichever form of financing you choose for your company, it is important to have a clear understanding of all documents executed and the obligations that arise. After all, taking on an equity investor is akin to entering into a corporate marriage. Taking on debt can also be a trap that is “easy enough to get into but hard enough to get out”.
Simone Bowie Jones is a Partner in Myers, Fletcher & Gordon’s Commercial Department. She may be contacted via email@example.com or www.myersfletcher.com. This article is for general information purposes only and does not constitute legal advice.