Growth; for most family businesses, it’s not only their aspiration but the means by which they are going to survive. It’s the basis upon which determined entrepreneurs thrive.

But deciding how that growth is going to be achieved can be a challenge in itself.

The traditional, and perhaps favoured, route for families has historically been to self-finance, essentially using their own money to grow the business. Whilst the great benefit to this is in retaining control and keeping the profits in your own pocket, it is rarely a sustainable solution for long-term ambitious growth.

For most, this means exploring the option to bring outside money in. After all, there is more than one way to fund a growing business, whether this be to increase what is already working or to create a source of capital for a new project.

The two primary options are to leverage debt finance or release shares for equity investors.

Each option has its own pros and cons which you need to weigh up as part of the bigger growth landscape, deciding which option is best for your business at a particular time.

Here’s our take on each.

Debt financing

 Funding inevitably involves borrowing. A business takes on an amount of debt, mainly in the form of a business loan or line of credit, to be repaid over time. Debt finance is mainly provided by banks, other lenders and crowdfunders, usually over a fixed term and with a rate of interest attached.

Securing debt finance can be a laborious process, governed by regulatory burdens and complex information requests; businesses will need to prove their current cashflow position, via copies of bank statements, as well as their credit worthiness. The amount you need to borrow, and your trading history to date, can be key influencers in determining your funding outcome.

But a shift in recent years has meant that debt finance is now widely available as an online funding solution too, meaning applications can be completed in just a few days using streamlined and paperless processes, however, the same core information is required.

A good example is invoice discounting. Typically, you will be able to borrow money against an invoice for a maximum of 120 days, paying interest on your borrowings accordingly – see our blog ‘Single invoice discounting: the pay-as-you-go finance solution’.

The advantages of debt financing

• Full ownership and control of your business is retained by you. The profits are yours and the lender has no claim on any equity in the company.
• On a fixed term loan, there is a clear end to your debt; once you have repaid the amount you borrowed plus interest, you have no further responsibility to the lender.
• A business loan, although complete with some terms and conditions, generally gives you the freedom to spend the finance as you choose, without investor stipulations.
• You can reduce the cost of the finance to your company by deducting any interest on the debt from your business’ taxes.
• If you have good cashflow management and are credit worthy, it can be straightforward to get approved for a loan or line of credit.

The disadvantages of debt financing

• In taking debt finance, you are committing to repaying a sum of money over a fixed period but cashflow problems could have an adverse effect on this.
• In the majority of cases, you will need to be a personal guarantor for a business loan and will be held personally responsible if you fail to make any of your repayments.
• Interest can be a constant drain on your bottom line, it is essentially revenue that you could be reinvesting into your business.
• The level of debt your business takes on need to be closely managed, carrying too much means you could be viewed as high-risk by other future investors.
• Lenders may not always grant the level of finance you request and there is little room for negotiation; a plan B for any shortfall is advised.
• Lenders may require additional security, such as a charge over your assets, for larger loan sizes – this applies for property loans in particular.

Equity financing

 Funding that involves giving away equity in your business in return for incoming capital, with the main objective being for you to retain the majority share. This is generally used by businesses in a pre-revenue, fast growth phase or by those looking to acquire another business with limited assets to finance.

Unlike debt finance, there is no fixed sum of money to repay, instead an equity investor gains a proportion of ownership in the company. This means that they would share in any dividend that is paid and profit generated when the company is sold, or you buy them out. They would also receive associated voting rights, as detailed in the shareholder agreements.

Equity finance is predominantly based on building close relationships through partnerships with family or friends or by seeking funding from angel investors, crowdfunding platforms or venture capital firms.

 The advantages of equity financing

• Investors receive their return from dividends paid from profits or via the sale of the business, there is no financial debt repayment involved.
• The associated risk is carried entirely by the investor; there is no obligation for you to repay the money if your business fails.
• Equity investment often comes with more than just a sum of money, it is a way to bring knowledge, expertise and contacts into a growing business.
• Without monthly repayments to make, you should have more available cash to reinvest into your business, encouraging faster growth.
• The day-to-day burden of running your business, including strategic decision-making, may be reduced by splitting it between yourselves and your equity shareholders, if you chose so.

 The disadvantages of equity financing

• You will fundamentally lose a share in your business, reducing the value of your current or projected dividends.
• The addition of extra people, with voting rights, means you’ll also experience an evident loss of control in your business, particularly with regard to decision-making, but again this will be detailed in the shareholders agreement.
• Finding the right investors can be very time-consuming, making sure they are a good fit, and buy in to your business vision and goals.
• Pitching to investors is a complex process requiring you to have a pitch deck and business plan, with supporting financials, to enable any investor to complete due diligence. You’ll also need to negotiate shareholder agreements and prove the long-term sustainability of your business.
• The only way to regain full control of your business is to buy out your investors, inevitably paying them more than they originally paid for their shares.

In summary, there is a role for both debt and equity financing when looking to grow your family business, the decision is ultimately based on which solution best suits your needs at the time. And this may change from one funding round to another.

If you are open to bringing external resource into your business, benefitting from more than just the capital injection, then equity finance could hold a lot of opportunity for you. If your long-term goal, on the other hand, is to retain full control of your business and the profits it generates, then obtaining fixed-term finance with regular repayments is a better solution.

If you’re looking for finance to grow your business but aren’t sure of your options, speak to one of our advisors.