Fund growth: debt versus equity

Securing any form of outside funding will place pressure on the owners of a business. Loans, for example, will need to be repaid and shareholders demand high returns. Therefore, financing a growth strategy needs to be carefully planned and managed. 

By James Benson, managing director of FDUK

If possible, always look inside the business for additional resource before taking on any external funding. You may be able to do this by bringing some sales forward or finding ways of reducing overheads. If external funding is really the only way to finance your growth strategy, then there are a number of options to consider:

•    Bank finance in the form of a loan or overdraft is usually cheaper than selling shares/equity in your business – those shares could be worth a lot of money one day. 

•    However, unlike shareholders, banks can force a business into liquidation if it doesn’t repay the debt to agreed terms.  The loss of your business is likely to be much more expensive than selling some shares!

•    An increasing number of businesses are also turning to invoice discounting or factoring as a means of balancing their cash flow and avoiding late payment issues. 

•    This type of asset-based lending, available through banks or private organisations, involves borrowing against your sales ledger – the lender will advance up to 90 per cent of an invoice as soon as it is sent out and some arrangements also involve the lender chasing payment of your invoices, which can save valuable time and resource.

There are of course situations where equity investment is the best option for businesses.

Equity investment is ideal for businesses which do not want to increase their level of borrowing or are unable to provide the necessary security. Two options are either Business Angels or Venture Capitalist

•    The Business Angels network consists of wealthy individuals looking to invest in growing companies.  Business Angels often bring much more than funds, and can offer contacts and advice.  To attract a Business Angel, businesses will:

o    be wanting to raise between £10,000 and £250,000
o    be willing to sell a share of the business in return for financing
o    be willing to develop a personal relationship with a Business Angel
o    possess an experienced management team which demonstrates an understanding of the product and market
o    be able to offer the Business Angel the option of an exit

•    Venture Capitalists are somewhat less angelic and have their own agenda.  They will only invest (usually a minimum of £2m) if they can see a significant return, for example three or four times their investment over three years.  They place significant pressure on the management team to provide a return and a means of exit (such as a trade sale of the business), which could see the whole management team leaving the business. 

In reality, for many businesses, raising funds is not an either/or decision and may involve several sources.  I recommend that you take advice from someone experienced in these matters to ensure that you get the right mix of funds for your business.

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By James Benson  on   Jul 09,2008

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Keywords

funding    banks    loans    investment    venture capital    business angels   

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