If your business is planning to raise capital through either debt financing or equity financing (selling shares of stock to investors), you may want to reconsider your choice of entity. Keep in mind several considerations.
Corporations May Offer the Most Flexibility for Raising Capital
Corporations offer the widest set of options for raising capital. While any business form can issue debt, corporations are typically the better vehicle for equity financing. With the corporate form, you can periodically issue stock to attract new investors (unless agreements in place forbid doing so). Partnerships and corporations are in a better position to attract venture capital financing than sole proprietorships. The corporate form may be more likely to undertake a public stock offering (“going public”). C corporations have greater flexibility than S corporations for attracting new investors or going public, as they do not have restrictions on numbers of shareholders and classes of stock. With most large public offerings in particular, the S corporation is impractical, as the goal is to attract a large number of investors. However, partnerships can also engage in equity offerings. Although there is no physical stock to issue with a partnership, it can engage in a master limited partnership, which is treated like a public stock offering and may be actively traded.
Caution: Accepting new investors, venture capital, and going public can reduce your control over the business.
How Other Entities Raise Capital
Contributions from shareholders and debt financing are the usual methods. Sole proprietorships (SPs) cannot issue stock to attract equity financing. In an SP, you and your business are, by definition, one and the same; there can be no other investors to add equity financing. Typically, partnerships do not issue stock but they may have units for ownership purposes. If your business is a partnership, it may have to dissolve and be reformed whenever you wish to expand the number of partner-owners. If your partnership agreement permits admitting new partners without a dissolution, then you can get around this hurdle. Partnerships are thus, at best, awkward mechanisms for equity financing. LLCs, which frequently structure themselves much like partnerships, face the same limitation. Practically speaking, if your business is an SP, partnership, or LLC, you add equity through additional direct contributions by you and any current partners or members. In a partnership or LLC, you have the advantage of a larger number of owners who can make direct contributions. Besides this limited means, though, you generally have to rely on debt financing.
Tip: LLCs and limited partnerships often face the general limitations of partnerships in attracting equity financing. They have one slight advantage, though. By offering limited liability, they may more easily attract investors. LLPs to a lesser degree can offer this limited risk.
When Form of Entity is Less Important than Number of Owners and Their Creditworthiness
Frequently, banks and other lenders require owners of small businesses to personally guarantee loans. Therefore, regardless of your choice of entity, it is important that you and your co-owners are creditworthy so that you can obtain the necessary debt financing. Of course, the more co-owners you have, the more opportunities you have for obtaining loans.
If you have questions, contact the Experts at Henssler Financial: experts@henssler.com or 770-429-9166.
Disclosures
The following information is reprinted with permission from Forefield, a division of Broadridge Financial Solutions, Inc. This article is meant to provide valuable background information on particular investments, NOT a recommendation to buy. The investments referenced within this article may currently be traded by Henssler Financial. All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. The contents are intended for general information purposes only. Information provided should not be the sole basis in making any decisions and is not intended to replace the advice of a qualified professional, such as a tax consultant, insurance adviser or attorney. Although this material is designed to provide accurate and authoritative information with respect to the subject matter, it may not apply in all situations. Readers are urged to consult with their adviser concerning specific situations and questions. This is not to be construed as an offer to buy or sell any financial instruments. It is not our intention to state, indicate or imply in any manner that current or past results are indicative of future profitability or expectations. As with all investments, there are associated inherent risks. Please obtain and review all financial material carefully before investing. Henssler is not licensed to offer or sell insurance products, and this overview is not to be construed as an offer to purchase any insurance products.
