In this episode of Coffee with Carl, attorney Carl Zoellner explains the different strategies for funding your business entity with equity or debt.
Updated August 13, 2020
If you watched the most recent episode of Coffee with Carl, you already know about funding a land trust. In this episode, I want to talk about the different strategies for funding business entities. In general, when it comes to funding business entities, we’re either talking about funding the entity with equity or debt.
Basically, you can fund your entity with either cash or assets. For example, assets you could use to fund an entity include a stock portfolio or piece of real property. Also, you could fund your entity with cash.
Differences Between Equity & Debt Funding
If funding a business entity with cash, that’s equity funding. The downside of equity funding is that, if the business entity is ever sued, all the cash that it holds would be available to its creditors.
If funding a business entity with debt, you’re lending money to the entity. With this method, it’s important that you hold your entity at arm’s length and only take commercially reasonable actions. As a result, this protects your entity’s corporate veil. If done correctly, you should be your business entity’s first creditor with the money you lent to fund it. This means that your personal loan to the business should not be available to a creditor if the business were sued or owed a debt. As you can see, using a loan to fund the business entity can be a nice way to protect your investment if you’re putting a large sum into it.
How to Fund Business Entities
Overall, there are different opinions on the best method to fund your business. Some will say you should use all debt funding; others will say all cash.
For me, it makes the most sense to put only a little bit of cash in the entity — enough to cover its liabilities — and use debt funding for the rest. For example, if I wanted to invest $100,000 into my business for a deal, I’d put $10,000 in as cash and the other $90,000 as debt for the entity. This way, the vast majority of my investment is protected, but the entity is still considered “adequately funded” in the eyes of the courts. This is important if the entity is ever sued.
Watch as Carl expounds upon the main differences between using debt or equity to fund a business entity.
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