Debt Versus Equity Financing - The Pros and Cons
When looking to secure more funding as your business grows, the debate between taking on debt or giving away equity comes up again and again. It’s crucial to understand the pros and cons of both options before deciding which option is best for your company.
Having a venture capitalist or an angel investor write you a cheque can be a very exciting and appealing proposition if you are looking to fund your business without taking on debt. However, where there are investors there are always strings attached, so it is worth considering your options before handing over equity.
● Networking - Having an investor with a strong network in your sector can lead to more business opportunities and added credibility.
● Cash Flow - You do not need to use your profits for monthly loan repayments which can help with short term cash flow as well as long term growth plans.
● Deferred Risk - If your business fails you do not have to pay back the investment, the investor is taking that risk when they hand over the funds to you.
● Long Term View - Investors do not expect to see a return on their investment straight away, they are able to see the long term potential in giving you their money, which relieves short term pressure off your company.
● Time Consuming - Whilst applying for a bank loan can be a time consuming process - it can take even longer to find, and convince, the right investor for your company.
● Giving Away Part of Your Business - In exchange for their money, investors will have some ownership in your company and a cut of your future profits.
● Loss of Control - As owners of shares in your business, investors can now have a say in how the business is run. This could mean you no longer have autonomy and may have to consult with investors before making decisions, be they big or small.
● Increased Total Cost - If your business is successful, it could actually cost you more in giving away profits than it would have done if you had paid interest on a loan.
● Irreconcilable Differences - In some cases, if you can’t work together with your investors, you may have to cash in your portion of the company and let the other shareholders run the business without you.
If you aren’t ready to give up a portion of your company, but still need extra financial resource for your next step, bank loans can be a great option. However, getting in to a cycle of debt that you don’t have the cash to get out of can be debilitating, for both you and your business. Approach lending with careful planning and consideration and you can make debt work for you.
● Autonomy - The bank will hold no ownership of your company and therefore has no say in how the company is run. You retain full decision making control and are free to take the company in whatever direction you choose. You also do not dilute your share of any future profits.
● Easier To Plan - When taking on a loan, the interest and principal amount are known figures (as long as you don’t take a variable rate loan). This makes it easier for future budgeting and planning.
● Short Term Relationship - Even if your loan repayments are spread out over a number of years, the relationship ends when the money is paid back. With investors the relationship can be indefinite.
● Tax Deductible - The interest paid back on loans is tax deductible, meaning that over time the loan can actually cost you less than originally budgeted for.
● Streamlining Processes - Not only can you make autonomous decisions, which allows the company to be agile and proactive, but you do not need to spend time communicating with investors and holding periodic meetings with shareholders.
● Deadlines - The money you borrow must be paid back by a fixed date, so there is little flexibility if you are struggling to pay back the loan within the allotted time frame.
● Vulnerability - Taking on a loan can leave your business vulnerable if sales are slow and cash flow becomes and issue. You need to keep to your monthly repayments to keep your credit score healthy
● Lower Investor Potential - Whilst a small amount of debt, that is managed responsibly, is nothing to be concerned about, relying too heavily on debt can make you ‘high risk’ in the eyes of investors.
● Your Assets - You are likely to be asked to pledge assets of the company as collateral. If you fail to repay the loan these assets could be seized.
● Cost - If not planned for correctly, the cost of paying back the loan and the added interest on top, can hinder the growth of a company. It can be difficult to expand and flourish if a large portion of your monthly overheads is made up of debt repayments.