Debt vs Equity Funding

by | Oct 27, 2016 | Small Business Tips & Advice

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Debt vs equity: we weigh up the pros and cons of both funding methods to help you work out which is most suitable for your business.

Champagne Piaff: their funding journey

Small businesses often need money to grow. This is true for companies in the seed, fledgling and later stages of development. Finding that money can be difficult, especially in the current financial climate.

Tighter lending standards and venture capitalists still recovering from the Brexit fallout means getting funded can be even more challenging than it already was.

Within the bracket of alternative finance, there are two main types of funding available to small businesses – debt financing and equity financing – both of which Code Investing can offer you assistance with.

But as a small business owner, which is best for you?

A lot of this will depend on what stage your business is at, how much money you need and whether you’re willing to sacrifice part-ownership of the company to get the funding you need.

Debt vs Equity

Equity Financing is possibly the most common form of crowdfunding that business owners and investors are familiar with. By offering a stake in your company, investors are investing in what they believe is the likelihood of your business being profitable in the future.

In simple terms, this means they get a future share of your financial success and as shareholders possibly (depending on percentages owned) some say in how the business runs. This can be a plus if your investors are business savvy and you seeking their active involvement.

Equity Financing

Pros:

  • There is less financial risk for the business owner if the business doesn’t succeed. Should this happen, you would only pay any remaining funds to investors after all debts have been cleared.
  • You may have more liquid cash available because you are not having to make regular repayments
  • Shareholders may be able to give industry specific advice

Cons:

  • You will have to give investors a percentage of your companyEquity means sharing your profits with investors
  • You will have to share your profits with investors
  • You may need to consult with your new partners any time you make major decisions affecting the company
  • The only way to remove investors is to buy them out, which can be more costly than the original amount they invested

Debt Financing differs from equity in several ways, the main difference being it doesn’t dilute ownership of your business.

Rather than investors taking a share in the company, they are loaning you the funds which you then pay back on a regular basis.  They are investing on the basis that they believe your business will be profitable enough to make regular interest payments to them and to return the capital.

Interest payments are most commonly monthly, but can also be quarterly, annually or at maturity (when the loan has reached the end of its agreed term). It’s at this point of maturity that you’d repay the amount you borrowed back to the investor.

Debt Financing

Pros:

  • You retain ownership and control of your businessDebt financing can make financial forecasting easier
  • It can be easier to forecast expenses because loan payments don’t fluctuate
  • You get to keep any future profits within the business once the loan is paid off
  • If you make the bonds convertible (into equity), investors can choose if they want to become shareholders, broadening your spectrum of potential investors
  • Interest on the debt is tax deductible

Cons:

  • If your business isn’t succeeding, you’ll still need to make regular interest payments
  • Once terms are fixed there is little flexibility, which can be tough if your business is unsure of short-term cash flow
  • If your business is at very early or seed stage, you may not be generating enough cash to pay interest and return capital loaned
  • You may need some form of security to back the loan with, which if it’s not available may make debt financing unviable

Which is best for your  business?

Just as every investor is different, your financial needs are unique to your business.  With both debt and equity it’s not a case of one size fits all.  Consider what is the best route for you, whether that is to give up a share of your company’s future profits or to make regular loan payments for the next three to five years for example.

Take a look at our debt and financing pages to find out more about the benefits of each option and ask your financial advisor for their opinion too.

On the other hand, if you already know what type of financing you need, fill in our debt or equity financing application form now and you’ll be a step closer to getting growth capital for your business.

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