What is debt financing?
Many of us are familiar with the concept of loans, you may have experience in borrowing money for a mortgage or for University Tuition fees. Debt financing a business is much the same. The borrower accepts funds from an outside source and promises to repay the principal plus interest, which represents the “cost” of the money you initially borrowed. Debt financing is widely available and is a popular avenue for businesses because terms are often clear and finite and importantly owners retain full control of their operations, unlike in an equity financing arrangement. However, some debt financing options can have steep interest rates and it is important to assess your ability to meet the repayment and interest terms. Another consideration is the potential for personal financial losses if it becomes impossible to repay the loan – whether a business owner is risking their personal credit score, personal property or previous investments in their business.
What is Equity financing?
Equity financing means selling a stake in your company to investors who hope to share in the future profits of your business, perhaps even a voting stake in company decisions depending on the terms of the sale. There are several ways to obtain equity financing, such as through a deal with a venture capitalist or equity crowdfunding. Compared to debt financing, equity financing is harder to come by for most businesses. This type of funding is well suited for startups in high-growth industries, such as the technology sector, and requires a strong personal network, an attractive business plan, and the underlying business (product, customer demand, team, etc) to back it all up. For businesses that successfully secure equity funding they will have capital on hand to scale up and will not be required to start paying it back (with interest) until the business is profitable. Important point to be aware of is if you relinquish more than 49% of your business, even to separate investors, you will lose your majority stake in the company. That means less control over company operations and the risk of removal from a management position if the other shareholders decide to change leadership.
The British Business Bank (BBB) offers an independent introduction to various examples of financing types within both debt and equity financing, what they will mean for your business and important things to know before making your decision. You can fine the full report here: The business finance guide: A journey from start-up to growth.
Ultimately, many companies use a mix of equity and debt options available and the mix will likely change as your business does.
Check out BBB’s finance interactive journey tool to help you find the finance options relevant to your situation. The guide and the journey have both been updated with new information and guidance to support UK SMEs experiencing financial challenges as result of the Coronavirus (COVID-19) outbreak – check out the video below for an overview: