Small firms raised a record £6.7bn in equity funding last year, according to the British Business Bank. Meanwhile, bank lending to small businesses fell, with firms across the UK wary of increasing their debt levels. The contrasting appetites for these two different forms of finance is interesting.
Traditionally, entrepreneurs have felt nervous about selling equity in their businesses, fearful of diluting their ownership rights and losing control. But in today’s febrile climate, the permanent nature of equity finance is increasingly seen as a less risky choice than debt.
The good news is that whatever funding your business needs, the range of options has grown dramatically. Once banks were the only game in town – that’s no longer the case.
Debt or equity finance?
In the stockmarket, funders now include business angels, crowdfunding platforms, venture capital and even private equity for larger businesses. In debt finance, the banks have been joined by invoice and asset-finance providers, loan-based crowdfunders, fintech challengers and more.
The financing you go for depends on what’s important to your business. Debt finance keeps the funder at arms-length, with no claim on your business and a return limited to the capital borrowed plus interest. It’s typically quicker and easier to arrange, and the loan cost can be set against the business’s tax bill.
On the other hand, loans must eventually be repaid and taking on too much debt can hold the business back. Servicing the debt – meeting repayments each month – can be a strain, particularly for a business with unpredictable cash flows. Loans typically require collateral and may impose restrictive covenants on the company’s activities.
Equity finance doesn’t have to be repaid or serviced, leaving the business unencumbered by a relationship with a lender. There is no collateral to put up and funders often provide softer support (such as advice) as well as finance. Earlier-stage businesses may find it easier to secure equity finance than debt.
The downside is giving up some ownership. That has long-term consequences – you’ll only be entitled to a share of future profitability and you’ll make less if the business is sold. But there are also immediate impacts: even if you only sell a minority stake, you may have to consult shareholders on key decisions, or even give them formal representation; at the very least you’ll have to keep them informed.
In practice, many businesses grow using a combination of debt and equity over time. But if your company does need funding, it pays to take the time to consider every option, rather than going straight to the bank.
In the news
Will the Investing in Women Code improve the availability of finance for female entrepreneurs? The government claims the initiative, unveiled last month, will be key to helping it hit its target of a 50% rise in the number of female entrepreneurs in the UK.
Signatories to the code include Royal Bank of Scotland, Barclays, Lloyds Banking Group, Santander, TSB, Metro Bank, the Co-operative Bank and Bank of Ireland UK, as well as several venture capital and business angel groups.
Each has committed to making a member of its senior leadership team responsible for supporting equality in access to finance. Code members will also have to publish regular data setting out their support for female entrepreneurs.
Research suggests men in the UK are 86% more likely to access venture capital for their businesses and 56% more likely to secure angel investment. The argument is that difficulty in getting hold of financing to get their ideas off the ground is one major reason why male entrepreneurs in the UK currently outnumber their female peers two to one.
So far however, attempts to turn this around have fallen short. Market research group Beauhurst reported earlier this year that while 6% fewer men won funding for their companies last year, the decrease in numbers of deals among female-founded companies was 15%. Just 16% of 2018’s equity deals went into such businesses.