Two contracts, two philosophies
The partner buys a fraction of the future: shares in profits and losses, votes, and cannot demand their money back — their exit is to sell their stake. The creditor buys a flow: interest and principal on agreed dates, with collateral if prudent, and no say in how you run things (except for covenants). Everything else — control, cost, taxation, risk — derives from that difference.
The real cost of each currency
- Equity: it has no monthly payment, but it is the most expensive currency if the business works: the 30% you sold for $2M may be worth $20M in a few years. It also dilutes control: board, vetoes, minority rights.
- Debt: its cost is visible (the rate) and deductible — interest is a tax-deductible expense for the business, subject to requirements and limits of the LISR. It dilutes nothing… as long as you can pay it: debt turns a bad quarter into a crisis, and the collateral answers for it.
Financial rule of thumb: debt amplifies good projects and buries bad ones. If the business's expected return exceeds the credit rate by a margin, leverage multiplies your return as a shareholder; if it does not, you are working for your creditor.
When each one makes sense
- Private debt shines when there is proven cash flow or assets to back it: working capital, machinery purchase, inventory for a season, a signed contract to be collected. Short and medium term, visible return.
- Equity is the currency of genuine risk: early stage with no cash flow, long growth bets, projects where a fixed payment schedule would be a noose.
- Hybrids (convertible debt, notes with warrants) bridge uncertain valuations: it enters as debt and converts into equity if the business takes off.
The third way that does not exist (legally)
The classic temptation of those who want neither to dilute nor to qualify for credit: "I raise money from acquaintances and promise them a fixed return." That —an offer to indeterminate third parties with a promise of repayment— is captación irregular (irregular deposit-taking): prohibited by art. 103 of the LIC and punishable with prison (art. 111). The legal versions of that idea are precise: real partners (they assume risk, with no guaranteed repayment), loans negotiated one by one and documented, or the securities route with registered securities. We explain it in depth in irregular deposit-taking.
Checklist before deciding
- Does the project have cash flow or assets today? → debt is viable. Only a promise of the future? → equity.
- Does the expected return exceed the available rate by a margin? If not, don't leverage.
- Can you survive 6 bad months while paying the monthly installment? Stress-test it with the simulator.
- What is worth more in 5 years: the % you would sell or the interest you would pay?
- Whatever the route: papers in order — a shareholders' agreement in equity, a secured mutuo (loan agreement) in debt.