When you need to raise capital for your development project, there are two primary options to consider: debt (senior & mezzanine) financing and unsecured equity. Whether you choose debt or equity – usually a combination of the two – often comes down to a few factors unique to your business and/or your project. Here, we’ll examine the features of both options, their advantages, and how to make a choice that best suits your needs.
What is debt financing?
Debt financing involves borrowing money and paying it back with interest at a later date. Bank loans, lines of credit, and even credit cards are examples of debt financing. You can get debt financing from traditional lenders, mezzanine lenders, and even friends and family.
The advantages of debt financing
Debt financing is one of the most common ways to fund the growth of a business or a new development project. The primary advantage of this form of funding is that you don’t need to give up a portion of the ownership in return for cash – you maintain full control of your project. As a result, the cost of debt capital is generally lower than unsecured equity. Also, in most cases, the return on the equity is higher as more leverage is used.
The debt market is large with several different types of lenders who specialize in development financing. As a result, capital is generally available and is a function of each lenders' risk tolerance. Some debt financing can be accessed as needed, without needing to reapply (i.e., with an operating line). And, with set repayment terms, it’s easy to budget for debt financing as part of your cash flow management.
What is unsecured equity?
Unsecured equity, on the other hand, usually involves selling a piece of equity, usually in the form of limited partnership units, in return for capital. The Equity is not secured on title and repaid after all other secured creditors. By selling a stake in your business or your project, you receive a cash investment in return.
The advantages of unsecured equity
The primary benefits to unsecured equity consist of no debt obligations/pressures to repay, debt terms and conditions to be met, guarantees pledged cumulating in increased flexibility. With no outstanding loan amount or obligation to a lender, all project proceeds flow directly to the owner rather than servicing debt obligations.
The other advantage to equity financing is the opportunity to learn from your investors, who may become partners in your business and provide access to networks that may open doors for growth and expansion.
Which option is best for your development?
Determining whether to choose debt financing versus unsecured equity (or more likely a combination of both) for your development project comes down to a few factors that are unique to your company and the project you’re looking to fund. There are some guidelines, however, that you can consider:
Debt financing may be a good choice for you if:
You can qualify for a loan/ line of credit
Getting a loan or line of credit for a new development project may not always be straightforward or easy, particularly if your company is new or the project comes with some risks. But, if you have a solid credit rating and a strong business case, you may qualify for a competitive interest rate.
You’re comfortable with the risk
Debt financing really comes down to betting on the future of your project. If you are confident it will be a success and feel repayment won’t be an issue, this may be the route to take.
You want to maintain control of your project
The more debt financing utilized the less equity required and therefore the potential to retain a greater share of the ownership of the project.
You want to improve your return on equity
With debt financing, you aren’t tied to sharing profits with investors, allowing you to keep more for yourself.
Unsecured Equity may be a good choice for you if:
You want to avoid debt
If you don’t like the idea of having to make a payment every month or don’t want to put up any collateral to secure a loan, unsecured equity financing can have a more positive effect on your cash flow
The higher the equity contribution into the project the more likely a lender is to provide debt financing
The higher the equity contribution into the project the more likely a lender is to provide debt financing.
You can find a partner that offers more than money
An investor who comes with valuable experience you can leverage or a network you can access can be a great partner that adds considerable value to your project.
You don’t mind giving up some control
If the financial demands of your project outweigh your capacity, you may not take issue with parting with some ownership or profits.
Many developers use a combination of debt and unsecured equity to help balance the financial demands of their development. If you’re not sure which option is best for your next project, MCAP’s Development Finance Group can help. With a depth of experience in the market, our Development Finance Group can create solutions that meet the unique and varied needs of our clients.
To learn about MCAP’s financing options visit our Development Finance page for more information.
