You need $40,000. Borrow it, or sell a piece?
The story so far The shop is doing well, and you want to open a second location. Tools, a lease deposit and a first month of rent add up to $40,000, and you don't have it. Two offers land on your desk. The bank will lend you $40,000 at 8% a year. A local investor will give you $40,000 for 25% of the business. One you have to pay back. The other you never pay back, but you give up a quarter of everything, forever. This lesson is about how every business, from a bike shop to Apple, gets the money to grow.
Businesses raise money two ways: debt (borrowing, paid back with interest) or equity (selling part ownership).
The choice decides who controls the company, who gets the profit, and how much risk the owners take.
Compare what each costs in good years and bad, how much ownership you give up, and whether the business can make the payments.
Commercial bankers make loans. Venture capitalists and angel investors buy shares in young companies. Investment bankers help big companies sell bonds and shares, including on IPO day.
What you're looking at: the two ways to get $40,000. On the left, a bank loan: you keep the whole business but owe the money back plus 8% a year. On the right, an investor: you never repay, but the orange quarter of the business now belongs to someone else.
Debt or equity: two kinds of money.
On the balance sheet in Lesson 12.2, everything a business owns was paid for by lenders or owners. Raising money is just choosing which one to add more of.
Debt
Debt is borrowed money. You pay it back on a schedule, plus interest, whether the business does well or not. You keep all the ownership. And interest is an expense on the income statement (Lesson 12.1), so a corporation pays less tax because of it. Big companies also borrow by selling bonds: IOUs that investors buy, which pay interest and return the money on a set date.
- The bank loan
- $40,000 at 8%: $40,000 × 0.08 = $3,200 of interest a year, plus paying back the $40,000 over time.
- Ownership
- You keep 100%.
Equity
Equity financing means selling part of the business. The investor never gets paid back. Instead they own a slice of every future profit, and of whatever the business sells for someday. Ownership is counted in shares, like the stocks you learned about in Unit 5.
- The investor's offer
- $40,000 for 25%. You keep 75%.
- In shares
- You own 3,000 shares. The business creates 1,000 new shares for the investor: $40,0001,000 = $40 a share.
Dilution
When a business sells new shares, every old owner's slice gets smaller. That's dilution. You still own the same number of shares, just a smaller percent of a (hopefully) bigger business.
- Before
- 3,0003,000 = 100%.
- After
- 3,0004,000 = 0.75, so 75%.
Valuation: pre-money and post-money
An equity deal quietly puts a price on the whole business. The post-money valuation is what it's worth right after the investment. Subtract the new money to get the pre-money valuation, what it was worth before.
- Post-money
- $40,0000.25 = $160,000.
- Pre-money
- $160,000 − $40,000 = $120,000. The investor thinks your shop is worth $120,000 today.
Leverage
Debt costs the same in good years and bad. Equity investors share whatever happens. So using debt, called leverage, makes good years better for you and bad years worse. Try it below.
- A $30,000 year
- Loan: $30,000 − $3,200 = $26,800 for you. Investor: $30,000 × 0.75 = $22,500. Debt wins by $4,300.
- A −$10,000 year
- Loan: −$10,000 − $3,200 = −$13,200. Investor: −$10,000 × 0.75 = −$7,500. Equity hurts less.
What you're looking at: what you'd keep next year under each offer, from a $10,000 loss to a $60,000 profit. Top bar: take the loan and pay $3,200 of interest. Bottom bar: take the investor's money and keep 75%. Simplified: it skips taxes and paying back the loan's $40,000.
The funding ladder
Businesses climb a ladder as they grow. First, bootstrapping: your own savings and profits. Then friends and family, and bank loans once there's a track record. Angel investors put their own money into very young companies. Venture capital firms invest in startups that could grow huge, in rounds called Series A, B and C. Finally, an IPO, an initial public offering, is the first time a company sells shares to anyone on the stock market.
- Where you are
- You started with $1,200 of your own savings and a $2,500 bank loan (Lesson 12.3). The $40,000 investor would be your angel.
Two minutes. Just listen.
Tap any line to jump to it.
Debt or equity?
Eight questions about how businesses raise money. Each one gives you the numbers. One try each.
What you're looking at: made-up businesses raising money. Each lists the deal, then asks one question.
The logic, step by step.
Before you take anyone's money, run these three steps.
Step 1: Can the business make the payments?
- The shop
- A profitable year easily covers $3,200 of interest.
Step 2: What does each option cost you?
- In a $30,000 year
- $3,200 of interest vs. $7,500 to the investor.
Step 3: What happens in a bad year?
- A −$10,000 year
- The loan still costs $3,200; the investor shares the loss.
Worked example: where's the break-even?
- With the loan, you keep profit − $3,200.
- With the investor, you keep profit × 0.75.
- They're equal when the investor's 25% share equals $3,200: profit × 0.25 = $3,200.
- Solve. Profit = $3,2000.25 = $12,800.
- The answer. If you expect more than $12,800 a year, the loan leaves you more. Below that, the investor does. And remember: the investor keeps 25% of every year after this one too.
Trees sell a share of their sugar.
Most trees partner with fungi in the soil, called mycorrhizae. The fungus threads through the ground and brings the tree water and nutrients its roots can't reach. In return, the tree gives the fungus a share of the sugar it makes from sunlight, every year, for as long as they're partners.
What you're looking at: an illustration, not data. A tree above ground and, below it, light threads of fungus spreading out from its roots. The yellow arrow is sugar going down to the fungus; the blue arrow is water and nutrients coming up to the tree.
Why this sticks. The tree never "repays" the fungus. It shares its output for as long as the partnership lasts, in exchange for help growing bigger than it could alone. That's equity.
The page you'd copy down.
- Debt: borrow, pay back with interest, keep 100%. $40,000 × 0.08 = $3,200 a year. Big companies also sell bonds.
- Equity: sell shares, never repay, give up a slice forever. $40,000 for 25%.
- Dilution: 3,0004,000 = 75% after 1,000 new shares.
- Post-money = $40,0000.25 = $160,000. Pre-money = $160,000 − $40,000 = $120,000.
- Leverage: debt makes good years better ($26,800 vs. $22,500) and bad years worse (−$13,200 vs. −$7,500).
- Ladder: bootstrapping → friends and family → bank loans → angels → venture capital → IPO.
Fill in the blanks
Grab a friend or a study group.
Pitch night
One person pitches a business and asks for money. The others offer either a loan or cash for a share. Negotiate the percent and the rate.
Follow a company
Pick a famous company and look up how it raised money: its first investors, its venture rounds and its IPO year.
Slider challenge
Using the slider above, find the profit where both offers leave you the same amount. Check it against the worked example.
Just you and your money.
These stay on this device. Nobody else sees them.
Exam-style questions.
Written the way a college exam would ask them. Each right answer on the first try is worth 10 xp.
On the job: you're a venture capital analyst
A software startup asks your firm for money. Here's the situation:
- The ask: $2,000,000.
- The offer: a pre-money valuation of $8,000,000.
- Shares: the founders own all 8,000,000 shares today.
- Profit: none yet. It's still growing.
- Your firm's hope: the company sells for $50,000,000 in about 6 years.
Your task: what's the post-money valuation, and what percent would your firm own? How many new shares at what price? If the company sells for $50,000,000, what's your firm's stake worth? Why isn't a bank loan a good fit here?
See a model answer
Post-money: $8,000,000 + $2,000,000 = $10,000,000. Your share: $2,000,000$10,000,000 = 20%.
Shares: price is $8,000,0008,000,000 = $1 a share, so 2,000,000 new shares. Founders keep 8,000,00010,000,000 = 80%.
If it sells for $50,000,000: your 20% is worth $10,000,000, five times the $2,000,000 invested. The founders' 80% is worth $40,000,000.
Why not a loan: with no profit, the startup couldn't pay interest (8% on $2,000,000 would be $160,000 a year). Equity investors accept that risk because a few big winners pay for the many startups that fail.
Where the money comes from.
What you're looking at: a map of where this lesson fits in the course. Read it left to right: the lessons it builds on, this lesson in the middle, and the lesson that comes next.
- Back · Unit 12What it owns, what it owes
- Back · Unit 12How the three statements connect
- Back · Unit 5What a stock is
- You are hereRaising money
- Coming soon · Unit 13Picking projects with NPV