November 26th, 2018 by David Kemp

You've got the seeds of a million dollar business - maybe you've been growing weed for years and you've been developing new strains and varietals, maybe you've discovered the most efficient way to extract oil from cannabis and hemp, or maybe you make the best pot brownies any of your friends have ever tried. But how do you get started? What's the first step to making it all happen?

In the immortal lyrics sung by Liza Minelli in Cabaret, “Money makes the world go around, the world go around, the world go around – a mark, a yen, a buck or a pound – is all that makes the world go around…”.

While Neil DeGrasse Tyson might happily explain that gravity, not money, actually makes the world go around, there’s no doubt about the importance of money in making things happen - whether you’re building the next Aurora or just creating the local craft cannabis cultivation business you’ve always dreamed of, you’re going to need some kind of financing. If this resonates at all with you, we hope you’ll find this series of articles helpful for learning about methods of raising money, where money comes from, and how to stay on the right side of the law when raising money. The subjects we will discuss are:

Article #1: Financing Your Company – Debt vs. Equity: the two main methods of raising money for your corporation

Article #2: Financing Your Company – Sources of Financing: venture capital, private equity, bank financing, friends and family, etc…

Article #3: Financing Your Company – Keeping it Legal: How to stay onside of cannabis and securities legislation


DEBT vs. EQUITY

The first decision to make when deciding to raise money for a corporation is whether you want to raise money through debt, equity, or a combination of both. I specify “corporation” because while many people will use the words “business” and “company” interchangeably, this series deals only with raising money for a corporation (ie. an incorporated company).

DEBT

Debt means you’re borrowing money that you eventually need to pay back. The deal goes something like this:

“If you lend me money to build my business, then I will pay you back the full amount in five years, with interest.” – you get your money, they get a nice return on their investment.

You’ve got my interest…

Usually, with debt financing, the riskier the investment, the higher interest rate you’ll pay. That’s why a mortgage (secured against a piece of real estate that normally maintains its value or goes up in value) will typically have a much lower interest rate than a credit card (ie. here’s some money, we hope you don’t run away with it). From an investor’s perspective, the higher the interest rate, the more potentially appealing the investment, because higher interest means the lender stands to make more money from the loan.

Upsides and Downsides

The upside of raising money through debt is that you maintain total control of the company, subject to any restrictions that your lender might require from you, and the amount you need to pay back is typically predictable – you give me money, you leave me alone to run my business, and I give it back to you in a few years, plus the agreed fees and interest. An added upside is that interest on business loans is tax deductible. The downside of raising money through debt is that regardless of whether the company is doing well, or poorly – you still have to pay the loan back. Also, high interest rates can sometimes be difficult to continue to pay, especially in the early stages of your business, when money is tight. Lastly, most lenders will want a personal guarantee from you so that they can go after you personally if your corporation defaults on the loan, and they will want to secure their debt against an asset you have – ie. if this venture fails and you can’t pay your debt, the lender will take your house, your car, or even your entire cannabis crop to satisfy your debt.

EQUITY

Equity means that you’re selling a part of your business by selling shares in the corporation. When you’re providing equity as security for a loan, the deal looks more like this:

“You give me money, and if the company does well, we all win – you get dividends when we have profits, and you get your share of the proceeds if we sell the company.”

In that deal, you get your money to build the business and the investor stands to make a good (or great) return if the company does well.

Dividend and Conquer

A dividend paid to investors is a portion of the profits paid to an owner of the company, also known as a shareholder, in relation to the how much of the company that person owns. A key thing to know about dividends is that everyone who owns a certain class of shares MUST be paid out an equal amount per share. You can’t have one Class “A” Common shareholder getting $100 per share and another Class “A” Common shareholder who only gets $1 per share. That said, different amounts of money can be paid out on different classes of shares, if the directors of the company so choose. For example, Class “B” Common shareholders can be paid $1 per share, or nothing at all, while the Class “A” shareholders are getting $100 per share in a given year. Why is this important? Because if you’re trying to raise money for your company, your investors will generally want the same class of shares that you have so they know you’re not going to leave them out in the cold once it comes time to share the profits around.

Upsides and Downsides

The obvious upside (to you, the person raising the money) to using your equity to raise funds is that, generally speaking, there is no requirement to pay equity investors back. By investing in equity, investors are taking the risk that “hey – maybe I’ll lose everything if this fails”. If it doesn’t work out, you wind up the company, and move on to the next venture (and maybe get featured on the next edition of Accelerate Okanagan’s “F*&k Up Nights”).

The first downside to equity is that, generally speaking, equity investors will want a say in how the company is run. Unlike debt investors, equity investors will want, depending on the size of their investment, a seat on the board of directors, a vote on who gets to serve on the board, or veto power with regards to certain key decisions. The second downside to selling equity is that if you do wind up “making it big” and selling the company to someone, you will only keep the percentage of the proceeds that matches your ownership, or shareholding, of the company – the other shareholders also get their part of the proceeds. The below simplified comparison illustrates why this matters:

Debt

  • You borrow $100,000 at a rate of 10% interest and start building your company.
  • You build an awesome company and Aurora wants to buy it, in the first year, for $1,000,000.
  • You pay the lender $110,000 (the amount you borrowed plus interest), and you sail off into the sunset with $890,000.

Equity

  • You sell $100,000 in equity to investors. Because you don’t have much of a company yet, they demand a large stake in the company in exchange for their investment; you give them 50% of the company for their investment.
  • You build an awesome company and Aurora wants to buy it, in the first year, for $1,000,000.
  • You share 50% of the sale proceeds with the investor, and sail off into the sunset with $500,000.

SUMMARY

This is a very (VERY) simplistic look at raising money, and you should consult the appropriate advisors (ie. lawyers, accountants, financial analysts, etc.) to design a plan that is the best fit for the business you want to build. But regardless of what method you choose for raising money, the decision of how to raise finances is one of the most important decisions you will make, and will shape the direction and operation of your company. Money may not actually make the world go around, but it will, if spent properly, help blast your business into the stratosphere.

Stay tuned for Article #2 on Financing Your Company where I discuss sources of capital; venture capital, private equity, bank financing, friends and family, etc.

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