Buy Equity in Your Startup or Loan it Money?

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David Cummings on Startups

Most information on bootstrapping and self-funding a startup revolves around capitalizing the business by buying equity (e.g. you and a cofounder each put in $5,000 to start it). I know one entrepreneur that insists on loaning his business money instead of buying equity in it (after an initial nominal amount).

Here are some ideas on loaning your startup money instead of buying equity:

  • Money loaned is easier to be reimbursed, assuming the business does well, compared to the effort of having the business buy back equity (e.g. it’s easier to get your money back)
  • If other shareholders are involved, it’s easier to decide on a loan interest rate rather than an equity valuation
  • If other shareholders are involved, and a loan is in place, interest on the loan takes precedence over dividends, thereby providing an income stream to the shareholder that loaned the money, in addition to being a more…

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