What’s right for your business: Equity vs Debt

Since joining Maven, Investment Manager Sajid Sabir, has reviewed many applications for the MEIF Debt Finance fund, and many are often more suited towards equity funding. It’s clear when speaking to business owners that there seems to be uncertainty between equity and debt funding and the ability to assess which is right for their business at the current moment in time.

What is equity finance?

Equity refers to the raising of capital through the sale of shares in the business to investors. Business owners looking to raise equity finance have more options available to them than ever before, these include: business angels, venture capital, private equity and crowdfunding.

Advantages of Equity:

• No repayments – capital invested in your business won’t need to be repaid and there are no interest payments involved.
• More cash to invest – as capital doesn’t need to be repaid it means the business has more cash in hand to reinvest in growth.
• Long-term view and follow-on funding – investors usually take a 3-7 year view to exit, therefore they do not expect a return immediately and may offer follow-on funding.
• More than just funding – investors often can bring with them valuable skills, contacts and expertise to support the business growth strategy.
• Share the risk – investors become a shareholder, therefore they share the losses incurred and in the case of the business failing, there is no requirement to pay equity investors back.

Disadvantages of Equity:

• Costly and time consuming – raising equity finance can be costly as the process may take several months and take-up a lot of management’s time.
• Dilute shareholding and control – owners will be giving away a portion of their shares in the business which may result in having to consult or gain approval from investors when making those important decisions.
• Profit sharing – profits are shared with investors in the form of dividend payments which unlike interest is not a tax deductible cost.
• Giving more away at exit – if the business meets its goals and achieves a successful exit then the return to investors could be more than the cost of investment.
• Reporting requirements – investors usually require detailed monthly reports which can be time consuming.

What is debt finance?

Debt financing involves borrowing funds from a lender which could be in the form of family and friends, financial institutions such as commercial banks or alternative financing companies. Key characteristics of debt funding are that the capital is paid back to the lender plus interest. Debt financing comes in many forms such as term loans, overdraft, asset finance, asset-based finance, invoice discounting and trade finance.

Advantages of debt:

• Quicker to arrange – process from application to draw down is generally shorter than receiving equity funding.
• Retain ownership – retain ownership of the business and avoid sharing profits.
• Flexible – there are a variety of debt funding options and terms can be tailored to the needs of the business.
• Variety of sources – funding can be sourced via traditional high street banks, friends and family, and alternative funders such as peer-to-peer lenders and government back loan schemes such as Maven Midlands Engine Debt Fund.
• Straightforward repayments – borrower knows what they need to payback which helps to better manage cash-flow and forecast expenses.
• Tax deductible – interest paid is deductible cost, therefore helping to reduce the company’s overall tax obligations.

Disadvantages of debt:

• Repayment is a must – capital and interest payments must be paid, even if the business is experiencing financial distress.
• Higher risk and collateral – carries higher level of risk since defaulting can cost the business assets or personal guarantee pledged as collateral. Default also negatively affects credit rating and ability to obtain future debt funding.
• Unable to reinvest for growth – since debt is an expense, therefore it may prevent reinvesting back into the business.
• Spending restrictions – some lenders may restrict how the money can be used, for example funding cannot be used to refinance existing debt or buyout other shareholders.
• No additional support – unlike venture capital and private equity investors, lenders rarely help the business with additional non-financial support.

If you are looking to fund your Midlands-based business and want to know whether you are eligible for funding from the Maven MEIF Debt Fund, please contact our team on 0121 231 7125.