Most companies start out with a five-year plan which will include expansion. When the time comes to take your product and business to the next stage, you may need to think about external investment. There are a wide range of lending options for SME’s and entrepreneurs who are looking for access to funding: from venture capital, government grants or accelerators and bank loans. Two of the most prominent sources of investment though are debt and equity financing. Read on to find out more of the advantages and disadvantages of these types of funding. Firstly though, what is debt and equity financing?
What is debt financing?
Let’s start with debt financing. In short, debt financing is borrowing money from a lender, normally a bank. There are various forms of debt finance, from loans, overdrafts, credit cards or lines of credit. You pay back the money you’ve borrowed over time plus additional interest or fees. Accessing debt finance isn’t that complicated so many SME’s or start-ups take advantage of this form of funding.
What is equity financing?
Equity Financing on the other hand is a way of raising capital whereby you sell shares in your company. As an example, you could receive £10,000 for a 5% stake of your business. What is different to debt finance is that you won’t be required to make repayments, your investors will get their money back through profits (or by selling their shares to another investor). There are different forms of equity financing, including private equity, venture capital or initial public offering. Speak to us to see which funding structure best suits your needs.
Pros and cons of debt finance
With debt finance, the main advantage is that you retain the full control of your business and don’t lose any equity in the company. This means that you don’t have the worry of decisions being taken out of your hands, or the possible change of direction for the business that you are not happy with. It’s also time-limited so once you’ve paid back the debt your liability is over, and your five-year plan is now moving to the next stage.
On the other side of the coin, you’ll need to consider some of the possible negatives that come with debt finance. If you are unable to keep up with the repayments on your loan, your lender could take assets or guarantees you used as security. Also, your payments could sky-rocket if you’re on a variable interest rate loan so make sure you fully understand the loan agreement.
Advantages and disadvantages of equity financing
One of the key advantages of equity finance is, not just the fact that you’ll get additional finance for expansion, but you also get additional equity partners to your team. We’ve all seen the contestants on the Dragons Den wanting either Peter or Theo to invest, more for their business knowledge and connections rather than the cash injection. Having an equity partner can take your business to the next level more quickly and you don’t have the worry of repaying debt.
But there are also disadvantages with equity finance. Remember, you are giving away a percentage of your business and with that comes giving away a certain amount of your decision-making power. Plus, you’ll also be giving up a percentage of your profit which could be more expensive in the long run versus debt finance.
The final thing to consider with equity finance is it can be a long drawn-our process with the involvement of lawyers, chasing the funding and the time spent managing your shareholders with up-to-date progress of your company.
Deciding between debt and equity financing
Now that you have an idea between debt and equity finance, you can choose which is best for your business expansion plans. It’s important to think about the value of your business. Would having additional equity partners be a real advantage in your plans or do you want to keep full control of the company? Debt equity may the better choice if you can control the repayments and it may cost you less in the long run.
We can help
Here at Pegasus Funding, we work with businesses at all stage of growth. We have the specialist financial expertise to help you with both funding and business advice including equity raising, debt funding and asset-backed finance. Talk to us today to find the perfect funding solution for you and your business.