Equity or debt finance – it’s a choice that lots of entrepreneurs face as they look to make their next funding step. And as any business adviser will tell you, there are advantages to both types of finance.
The right option for your business depends on what you’re trying to achieve, how much money you need and ultimately, whether or not you’re prepared to give up a share in your business.
Re-evaluating the relationship between equity and debt
Traditionally, equity finance was seen as big sum funding, while debt finance was viewed as a short-term option for smaller amounts.
But the two types of funding are not quite as different as they used to be. Finance providers are waking up to ways equity and debt finance can work together to help a business top-up their funding pot and even help them access new types of finance.
Combining finance types can help businesses reduce the cost of capital. Because debt funding tends to be cheaper than equity, businesses can blend the two to reduce the overall cost of finance.
And it works the other way round too. Equity can help businesses raise debt, because it acts as a sign of validation for lenders. Plus, the equity cushion reassures debt providers that the debt can be repaid.
While there’s no issue in exploring multiple finance options, there are a few watch-outs for ambitious businesses.
Looking at too many different finance options can make you seem unfocused, which may be off-putting for some investors.
Investors may be wary if the business is over-leveraged.
Thinking beyond the equity and debt categories
Securing both debt and equity sources of finance is one way for businesses to get the most value out of each. But new providers are emerging to create an even more innovative solution that maximises the strengths of both solutions.
Mezzanine finance for example works like a debt product, but at the point of default, businesses will give up an equity share of the business as payment.
By combining the best of both worlds, mezzanine finance lets business owners access ‘equity-sized’ amounts of cash, whilst keeping total control of the company.
And the solutions are becoming more creative still, as Catherine Lewis La Torre, CEO of British Business Bank Investments, explains: “there are a number of providers who have a hybrid debt-equity approach. These ‘supercharged’ debt solutions are a one-stop shop for businesses who are looking to grow.”
Often, this manifests itself as primarily a debt solution, with a flexible repayment schedule. And to make the deal work for the fund, the debt approach is mixed with a small piece of equity to provide a larger return.
But crucially, these personalised solutions look at the fundamentals of a business and provide a financing structure that combines the right elements of both equity and debt, so that the finance is tailored to the business.
“It’s more bespoke to your business need, rather than relying on a formulaic approach. These specialised private debt funds can provide more innovative and flexible solutions for businesses.”
|Catherine Lewis La Torre CEO @ British Business Bank Investments|
By considering this kind of finance, businesses who previously thought they would be excluded from a pure equity or debt solution can carve out a space for themselves within the funding landscape.
Understanding how the business matches funding requirements is key. Especially for businesses who have applied for a pure equity or debt product in the past and been rejected – it’s important to know that there are other options out there. One fund’s rejection will be another’s acceptance, and the business may have just been looking in the wrong place all along.
Private debt funds can offer a fresh alternative and a new way forward for businesses that have struggled to find the right solution for their financial needs.