As a business owner at whatever stage your business is at, one of the primary questions will be “how am I going to raise the money I need to operate my business?” The answer to this is likely to be either debt or equity finance.
“Debt” is the borrowing of money which is to be repaid at some stage in the future and “equity” means raising money by selling a stake in the company. For example, a family member may decide that he or she would like to invest in your business. This could be by way of lending the business some money (debt) or taking a stake in the business in exchange for providing capital (equity).
To help you decide which option is best for your business, we have listed the key benefits and drawbacks of each one below:
Equity Finance
This does not necessarily have to come from just family and friends. You could also consider angel investors, wealthy individuals or other business people or venture capital funding.
Advantages
- Angel investors and venture capitalists may be able to provide guidance and assistance for your business that it might not already have access to. These investors are often very well connected people!
- You can use the cash invested for your costs without being concerned about being saddled with debt.
- As long as you have had an open dialogue with your investors, they will understand that if your business does not take off as hoped they will not expect to receive their money back if you are unable to repay it.
Disadvantages
- Although the potential to have someone with great business acumen on side is an obvious advantage, you will need to be very careful about whom you let into your business. Make sure it is someone that knows your industry and who will not want to take the business in a direction that you are not happy with.
- The investors will own a portion of the business — the size of which will depend on the investment that has been made. You will need to be open at the outset as to how much control you are prepared to give to an investor in return for their investment.
Debt finance
The most typical form of debt financing for small firms is by way of bank loan. Most of the time, the loan will be secured against the assets of the company. In the event that the company is unable to repay the loan, the lender has the right to claim the assets to pay off the debt.
Advantages
- You do not lose control of your business in the same way you might if you were to use equity finance — operational business decisions will largely remain your own.
- The lender will not take a share of your profits — you just need to make sure that you’re making your repayments on time.
- You can choose the right sort of borrowing to suit your business needs. For example, an overdraft facility might be the best option if you only require short term borrowing. On the other hand, leasing and hire purchase might allow you to raise more money than a standard loan.
Disadvantages
- For a company in the early stages of its life, borrowing money can prove to be a huge burden. Loan repayments may come at a time when you need funds to develop your business further and result in cash-flow issues.
- If you don’t make your repayments on time that has the potential to damage your credit rating which will mean that future borrowing might be difficult. In addition, there is the potential to lose your assets.
- If you choose to borrow money from family and friends and are unable to repay, there is a high risk that this could cause tension and strained relationships.
Having considered these options, also ask yourself the following questions to decide what’s best for you?
- How much money do you need and for how long? If you only require a cash injection in the short term then you might want to consider an overdraft.
- How much control are you prepared to part with? Be mindful that if you seek equity finance then there is the potential for you to lose some decision making power in exchange for a stake in the business.
- Do you foresee any cash flow issues? If so, be very careful with obtaining debt finance. It is likely that you will be asked the pledge an asset to secure the loan so you do not want to risk losing it if you cannot make a repayment on time!
Please contact the Trowers’ team for more information. We have also produced a series of fact sheets to help you, so click here to access our online resources.