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This article will give you the need to know details of Equity vs Debt Financing.
For most companies choosing between equity and debt financing isn't a choice between one or the other, but choosing what is right for the firm at the time for where it is at in its growth.
These two financing methods are quite different, having pros and cons that shape the ways in which you can grow your business to suit your business goals.
Equity Financing is the process of raising capital through the issued sale of equity instruments. High net worth investors and institutions provide the company with the capital it needs to maintain the business in exchange for shares or ownership of the company.
This doesn't mean surrendering control of one's business as an investor can take a non-controlling - less than 50% - minority stake in a business in exchange for working capital.
Examples of equity instruments include common stock, convertible debentures, preferred stock, and transferable subscription rights.
Debt Financing is when a firm receives working capital by selling debt instruments to individuals or institutional investors. The investors place interest on the money lent, with payments expected to be repaid by the receiver of the loan monthly, half-yearly, or towards the end of the loan tenure.
Debt instruments are assets that require a fixed payment to the holder, with interest. Bonds (government or corporate) and mortgages are examples of debt instruments.
Profitable and well-established businesses with a proven track record of sales are much more likely to qualify for debt financing, whereas smaller or start-up businesses will find it harder.
The reason larger businesses have an easier time attaining debt financing is that the business would likely have valuable collateral should the loan not be repaid in the agreed time frame. What’s more, a larger business is more likely to pay the loan back in the agreed time frame.
Equity financing takes longer due to the negotiating process regarding the investment package.
The potential long-term value of the business is evaluated between the principal owners and the investor in relation to the percentage amount staked for funding.
It typically takes around eight weeks for an equity release to complete and for your business to receive the agreed-upon funds. Some applications completed in as little as three weeks, though complicated negotiations can take many months.
For debt financing however, the turnaround, whilst involving scrutiny, is a lot quicker and is flexible with short or long-term loans.
The key difference between them is that with debt financing you are prioritizing maintaining ownership of your company and agreeing to hard full-stop deadlines that need to be met. Whereas with equity financing you are accepting a potentially longer period of time to find the right shareholder, but with there being no hard deadlines to be met in so far as loan repayment is concerned.
For small and start-up businesses qualifying for a loan that is competitive can be difficult and often require the guidance of a credit broker.
Investors look to a firm's credit score, how much time the company has been in business, how strong the business's financials are, and what collateral the business can offer.
Because of this scrutiny some businesses will be more likely to choose equity financing simply because they’re unable to qualify for debt financing at a competitive rate that works for their business goals.
It’s natural for businesses to want to avoid debt, Equity Financing is a method of gaining working capital that helps to do so.
Equity Financing may involve less risk because there is valuable collateral at stake and a loan to be repaid. It can burden a business's cash flow needing to make regular payments on a loan, hindering a company's growth.
A young business may not know what level of income that can be relied upon in a given period. This may make equity financing necessary if the business can't qualify for a loan that is also a fair non-predatory valuation. The greater the debt financed loan, the greater the uncertainty the company over paying it back.
Securing the working capital your business needs is undertaken with the expectation your business will become or will continue to be profitable in the long term. Taking out a loan and repaying it on time will build your business credit score sooner rather than later and will lead to better rates and returns.
It’s worth considering how much on-going scrutiny you’re comfortable with.
With Debt Financing, you would be planning to use debt to increase your business's earning capacity. With Debt Financing, you'll be aware of how much you will need to repay the lender; the principle plus the interest for the term of the loan.
However, with Equity Finance, parting with a percentage of your company can be a blessing, or a curse, depending on who you are partnering with. There is no end in sight, more things are left to chance and shareholders need to be consulted with regularly. The more shareholders the greater amount of scrutiny will be placed on the principal shareholders of the company.
Equity finance doesn't carry with it the burden of paying back a loan. It does however affect long-term profit sharing; maintaining as much control of the company as possible is a concern for principal owners.
Because equity financing involves drawing in reputable investors it can be a great opportunity to work with individuals with industry knowledge or experience.
We take the time to understand your business and its needs in order to find the finance product that is best for your situation.
We’ll help you stay away from a time-consuming, inflexible finance arrangement that hinders rather than helps your business grow and succeed.
We’ll be with you every step of the way bringing our expertise and trust in the industry to make the funding process as easy as we can.
As a founder of multiple businesses, Jamie believes that mindset, discipline and ambition are key drivers for success, both for his businesses and for his clients.
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