This article first featured in the August edition of Business Leader’s Business Money supplement, covering the panel debate hosted by Growth Lending in collaboration with Business Leader. You can watch the full debate here.
Debt and equity remain the two most popular ways to fund a business venture or supercharge its growth journey. We look at the benefits and drawbacks to both funding levers, giving you an insight into how you can best maximise each option.
It is rare to see a business that doesn’t raise funding at some point in its life lifecycle and television shows like Dragon’s Den have historically made giving away equity a much more palatable proposition than taking on debt.
However, Alex Wright, who is the founder at Dash Water, believes that giving away equity early in a business journey is not always a smart move.
He explains: “When funding growth in our business, we raised both debt and equity in the early years, but when you give away equity in your business, it is very hard to get back because the value of your equity may be more valuable in the future. So, the longer you can delay giving away equity the better it can be for your business.”
Alex also says that one of the key benefits to debt financing is that it enabled him to enhance his working capital cycle, especially in the earlier days of the company, and debt also enabled him to scale-up much faster
Dominika Minarovic, who is the Co-founder of BYBI Beauty, says that when growing her company, she has always tried to supplement an equity round with debt.
She explains: “As a start-up, raising debt or unsecured finance can be challenging as you won’t always have assets to lend against. So, what we try and do is maximise an equity round and use it as leverage to get good debt.
“Giving equity away at any stage can be impactful for your own stake holding though. Many founders struggle down the line as they may have given away thirty or forty percent of their business and then, when the company is more successful and established, you don’t have as much equity to give away and this can impact how much you are able to raise.”
Debt vs Equity – What are the barriers?
There are pluses and minuses to raising both debt and equity and Julian Hornby, who is Principal at Growth Lending, elaborates further on what they are, when it comes to debt.
He says: “The key part of raising debt is understanding what the collateral is that the borrower can use to leverage and raise cash, whether this is inventory or machinery, for example. Companies with no track record and without a huge asset base to lend against will naturally find this harder. Earlier stage businesses may need a personal guarantee and that is a big decision and it is a barrier that can sway individuals towards equity.”
It is also important for businesses to consider the implications of raising equity, if they have debt on the books too.
On how best to approach this, Tom March, Managing Partner at Redrice Ventures, says: “You need to have the comfort that, if there is debt in the business, it is serviceable and that they will maintain that approach if they bring equity into the business too. You can use debt to benefit everyone in the business and it can work well alongside equity, which is a better funding lever if you are investing in growth and innovation.”
About debt working alongside equity, Julian adds: “It can be a positive if somebody has raised equity and is now looking for additional debt, but we need to make sure it is extending the growth runway and you are not throwing more cash into a failing business. If we can sit alongside an equity provider and gain the confidence that the business is performing well, then it can work.”
Leveraging the network of investors
Dominika also says that funding growth in your business using equity enables you to access benefits that debt funding can’t give you, such as accessing a network of experienced investors and gaining support and learning from them.
She says further: “A debt partner is typically much more transactional and less focused on the nuances of the business. I have also been guilty of using equity financing for working capital, which is very expensive and very inefficient. Equity funding should be used for growth and not working capital, so you need to be very clear about what you will use debt or equity funding for.
“VCs are very much focused on the team and the founders and their vision, whereas debt providers look at the balance sheet of the business and they don’t like loss-making companies. VCs don’t mind if they can see a growth path. It can be framed as responsible lending versus ambition and vision.”
Alex agrees that making the most of the investors you bring on board is important, and he always asks one question when he is going through a funding round: how are you going to add value to my business?
“For us, it’s not about going for high-profile names for the sake of it but bringing people on board who are going to add value. If they are taking equity in your business, you need to ensure they are only demanding of your time in a positive way and they align with your vision, won’t cause friction with other shareholders, and cause any disruption. Good equity investors can add lots of value to your business if you bring on the correct ones at the right stage of your business.
“Investors can promise the world and it is important that you dig into the details and what time investors can give you. If you need to write this down, then it is worth it.”
Cost of bringing on debt
When it comes to bringing on funding there are also costs that business owners and professionals should be aware of.
Dominika explains: “You need to think about legal costs when you are bringing on equity or debt. There are costs to drafting a shareholder’s agreement, for example.”
Alex adds: “It is also worth looking into how the hierarchy of debt is structured within your business, as you might not want existing debt to be subordinate to other debt finance in the business. You also need to confirm you are OK with how your debt is structured, from a legal perspective.
“The time consumed raising funding is pretty hefty too, both from the preparation of investment and financial information to answering questions around due-diligence.”
Another subject that is quite rightly getting lots of airtime in the funding sector is diversity and inclusion, but with less than three percent of all VC raises going to female founders, there is much more work to be done.
On what advice Dominika has when pitching to investors, she says: “You need to have lots of confidence and you to have a clear vision about where you want to take the business. Don’t be burdened by the tales of the market. You also need to know your numbers and even if they don’t understand your business or sector, they’ll be impressed by the growth potential of the company.”
On this subject, Alex says that he has applied the Rooney Rule in his own business, whereby a minimum number of candidates that he interviews need to be from an ethnic minority background and it could be a suggestion for funders applying this role with the portfolio of businesses they see.
One of the overarching challenges facing the funding space, is the cost of debt rising due to inflation and the base interest rate rising.
Alex concludes by saying that the market is tough, but there will always be opportunities for strong companies: “In times like this, the tide goes out and you can see who is swimming naked. Businesses that operate in favourable times but do not have a good business plan, will struggle when conditions worsen. My advice is whatever funding you bring in, make sure you get a bit more and don’t be too cute with the quantity you’re trying to raise.”