Small businesses raised over £14bn of equity finance during the first three quarters of 2021, new data from the British Business Bank reveals, a 130% increase on the same period of 2020. Small businesses’ borrowing, meanwhile, actually declined last year.
Every growing business reaches a point where they have to think about raising money, and deciding whether to look for equity funding or debt is a finely-balanced decision. The good news is that more of both is available than in the past: private equity and venture capital firms are awash with capital to invest and banks are now lending more freely in the wake of the pandemic.
Some of the advantages of taking equity are obvious. There are no repayments to make, giving the business more freedom to invest. There’s no requirement to put up any collateral – and businesses don’t have to worry about conditions attached to loans such as performance covenants.
Subscribe to MoneyWeek
Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE
Sign up to Money Morning
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
Equity finance also comes with other benefits. Most investors are keen to provide more than just capital support.
They may also offer access to specialist expertise that can boost your business, or be able to introduce you to a broader network of partners and potential customers.
As co-owners of the business, they’re keen to help you succeed. It’s also likely that you’ll be able to raise substantially more funds in equity capital than is available in debt.
The upside to borrowing
The downside to equity is that you’re diluting your ownership of the business. That has pecuniary impacts – you’ll see less of the benefit as it grows in value – as well as practical ones. Business owners will need to get used to collaborating with their new partners – that may not come naturally if you’ve been flying solo until now. By contrast, borrowing money – from a bank, or another source – will leave you in complete control of the business, as long as you’re staying on top of repayments and the terms of the loan. And there are other upsides to debt finance too. One is that interest charges on loans can usually be set against your business’s tax bill.
That makes debt finance a tax-effective way to raise money. It’s also more straightforward: lenders will want to look at your application for finance carefully, but the due diligence process in an equity investment is more demanding and takes longer; there will also be legal costs to pay with the latter. Another plus point is that the loan has a limited life. Once the debt is repaid, the business is free to move on – or to arrange new finance if required. And in the meantime, if you’re able to fix the cost of the loan via a non-variable interest rate you can at least plan for the repayments, building this commitment into the business plan for as long as required. That said, the cost of the loan will reduce the business’s profitability and might even take it back below break-even point. It’s possible to get to a point where you are over-borrowed: the fixed cost of debt is disproportionate relative to the business’s trading performance, and therefore holds back its ability to grow.
Evaluate your needs
Ultimately, there is no right answer to the question of whether debt or equity finance is best for your business – it will depend on its needs and circumstances. Early-stage businesses in particular may find lenders are nervous about advancing funds and so equity may be the only way to raise growth capital. If in doubt, take independent counsel from a professional adviser such as a corporate financier
-
The countries where you can earn more than UK – and work lessBrits could earn the average UK wage up to 15 weeks sooner in thirteen different countries. Where could you earn and work less?
-
Review: Hotel Barrière Le Majestic Cannes – the grande dame of CannesMoneyWeek Travel The stars may have arrived for the Cannes Film Festival, but Hotel Barrière Le Majestic Cannes is the true star of the show
-
'Rachel Reeves' plan to force pension funds into UK assets won't work'Opinion Hustling pension fund cash into British assets sounds like a good idea. It would be better to make Britain an attractive place to invest, says Matthew Lynn
-
Supersonic travel: How China could 'leapfrog' US and Europe's commercial aviation industryOpinion Innovation in commercial aviation has been stuck for 60 years. A commercial supersonic jet might be back on the market soon, but will China get there first?
-
How British businesses can tackle Trump's tariffsThe majority of British businesses are likely to take a hit from the chaos caused by Trump’s tariffs to reorder global trade. Companies in the firing line face some difficult decisions, says David Prosser
-
Trump wants to colonise Mars – will it happen?Donald Trump wants to plant the US flag on Mars. Could humans really live there?
-
Why are energy bills so expensive in the UK?Electricity bills in the UK are higher than in any comparable rich country. Some blame the net-zero zealotry of the government for that. What is really to blame for high energy bills?
-
Will Putin invade Europe? Why investors know Russia is a paper tigerOpinion Markets are right to ignore talk of Putin invading Europe, says Max King.
-
Why French far-right leader Marine Le Pen has been banned from running for officeMarine Le Pen, presidential candidate and leader of France's right-wing National Rally party, has been barred from standing by the country's judges.
-
Five years on: what did Covid cost us?We’re still counting the costs of the global coronavirus pandemic – and governments’ responses. What did we learn?
