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Debt and Equity Financing for Businesses

Just like with private individuals, corporations and businesses can run into cash flow problems or have a need for a sudden capital influx. Financing the business is often a solution to this dilemma (e.g., a third party will loan/invest the business money in exchange for something). And should the business owner(s) choose to pursue financing, he or she will have to decide between equity financing versus debt financing. This determination will hinge on the type of business entity and the financial tolls available to the business.

Equity financing involves allowing a third party investor to participate in business control, profits, and/or appreciation in business value. In exchange for the investor’s money, the business will yield one of the foregoing as contractual consideration. Because this type of financing will affect the ownership of the corporation, stocks and the decision-making process are usually impacted. For corporations, the most common type of equity financing comes from RSMo 351.180, where a corporation can create different classes of stocks with preferences/limitations for the investor. Granting an investor voting rights, preemptive rights, dividends, and priority upon corporate liquidation are also common equity financing arrangements.

Debt financing, on the other hand, is where an investor lends or invests in a  business in exchange for the business promising repayment plus interest. Unlike with equity financing, things are a little more limited. There is only so much one can alter when deciding on the terms of the debt (e.g., terms of payment, amount of investment, interest rate, penalty provisions for default, etc.). However, some of the more prominent businesses and corporations will rely on RSMo 351.387(7), which explicitly provides corporations with power to take on debt obligations through the issuance of debt securities (unless the articles of corporation provide otherwise).

A business owner needs to approach financing decisions with prudence. Is the financing needed? Are you prepared to part with ownership or profits of the business? To what extent must the Articles of Incorporation, Bylaws, or ownership shares be readjusted? Or do you simply want a debt financing arrangement with a repayment plan? Because of the many areas involved in debt and equity financing (business entities, business law, secured transactions, contracts, etc.), it’s important to converse with and utilize legal counsel.

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