How to turn debt into equity?

The biggest challenge of most start-ups is liquidity. You want competence and things you can´t pay for and you want a solid balance sheet to show to your stakeholders and to ensure you can handle hard times ahead.

The most fundamental way to strengthen the finance of the company before it has scale and is profitable on its own merits is to bring on investors as shareholders. Simple; you offer them for example 100 shares in the company for an amount of 25 000 USD which gives them 5 % ownership in the Company. This will be based on the valuation of the company that will, before it has big business and turnover, be based on forecasts and expected revenue or, if you are fortunate enough to already have an investor in, the last transaction value. (Cf. the IPEV guidelines that are used on the global private investment arena.)

However – sometimes you cannot find an investor that can provide you cash up front. Sometimes you and another stakeholder identify other values/service/skills/products etc that he or she can bring to the company to help it grow. And you don´t have the liquidity to pay for this right now given your bootstrapped start-up mode.

2 ways to apply – the first being sweat equity. I have already written about this. Basically, you work for the shares in the company instead of cashing up for them. However, in Sweden you must be mindful of this potentially being seen as de facto payment for work. If so, your company must pay social security etc (i.e. liquidity draining tax costs) and the provider of sweat must pay income tax (so called dry income because you incur tax even though you have shares and have not gotten any cash to pay it with). A solution is the personal stock option program, but that only works if you intend to employ long-term and qualify also in other specific angles if you want the options to function as a remuneration/incentive. They are limited in their use.

The second way? Perhaps not as known, but actually very efficient in many cases. When you issue new shares you typically do it for cash. You can also do it for specific tangible things such as real estate or products, machines etc. And, here is the key, you can do it to offset a debt. To take care of an invoice. This invoice can be for delivered services to the company. As long as the debt is real, complies with accounting principles etc this is a great way to turn debt into equity, to get the competence you can’t pay for but need, and to get the great shareholder base with the right persons having skin in the game!

Sounds like latin to you? No worries, I´m the nerd on the subject. DM me anytime.

Katarina Strandberg
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