Debt vs Equity
Securing capital for your business growth or start up can be a great thing and though we are spoilt for choice in terms of where we can source capital from it is important to remember that not all funding is for you. As a business you need to be just as discerning about where you get your financing as financiers are about where they put their money. Not every source of capital is right for your business, and it is important to understand not just what your options are but which ones would be the best fit for your venture.
There are a number of different categories, and subcategories, of funding available to businesses but here we are going to focus on the two most popular capital sources – debt and equity. Debt financing involves getting funding from a lender which has to be paid back, typically with interest, over a certain period of time; equity financing, on the other hand, does not need to be paid back in the conventional sense, instead the financier gets an ownership stake in your company and makes their return through dividends or selling their share in the company later. Each of these financing sources has its pros and cons and the choice you make should take the following three key factors into account.
The first question you need to ask yourself is, what are you trying to achieve with the capital you seek. Are you looking for capital to cover a short-term funding gap or do you need the funding to finance long-term growth strategies which may take some time generate income? Keep in mind that debt financing has to be paid when the payment comes due whether or not you have generated revenue, so understanding the workings of what you wish to finance, and its cash flows, should give you an idea of whether debt financing will be realistically sustainable or if you may need slightly less rigid capital like equity.
However, before you jump to the conclusion that equity is best because you may not have to pay it back before you start making money, first seriously think about whether you are ready and willing to give up some control of your business. As explained above, equity financing means you are selling part ownership of your organisation and, whether you are a sole proprietorship or stock exchange traded corporation, this means current owners have to cede some control. What this will mean for the current owner(s) will depend on the number of shareholders, value of the company and amount being sought; and these factors in turn will also help you determine whether it is worthwhile to go through the process of getting equity funding, which can be a bit more involving that signing a loan agreement. So, although on the surface equity financing may seem like the easier option you also have to take into account how bringing in new owners with different ideas and ways of doing things could impact your business; in some cases they may bring more value than just their funds but in other cases it could lead to friction and undesired changes.
Once you have a better understanding of why you need funding and if you are willing to give up some control to have it, the third most important question you need to address is – how much will it cost? The cost of debt financing is clear, it is the interest rate, and though equity financing does not ask for interest payments it has a cost too. Understanding and weighing the cost of capital available to you, also in relation to your current cost of previously sourced capital, is important to help you gage your capacity to take on each type of funding. You have to be able to afford your capital otherwise you could find yourself having to sell assets or liquidating completely.
The process of sourcing capital involves a lot more than simply picking one. There are many factors you need to dig into in order to get an understanding of what will serve you the most and help you achieve your long-term goals and success. The abovementioned factors, while pertinent, only make up a small part of what you need to think about when deciding on whether you will seek debt or equity funding, and it is important that you take an adequate amount of time to weigh your options. With every client we work with at Baker Tilly Capital we understand that each business is unique and, therefore, requires bespoke solutions to their capital sourcing endeavours, and you as a business owner also need to understand that about yourself. It can be a daunting and somewhat strenuous choice to make so, if necessary, get the help and expert advice you need from trusted advisors, whether that is friends, colleagues or Baker Tilly Capital.