Equity finance vs debt finance — what’s best for your business?

When you’re looking to take your business to the next level, securing some outside money can be the simplest way to meet your goals. If so, you may be considering equity finance or debt finance. Which, though, is right for your business? To help you make the right choice, we take a look at what the terms mean, their advantages and disadvantages. Let’s walk you through them.

What is Equity finance?

Equity finance works by exchanging incoming capital for ownership rights. For example, to get £10k you could give up 5% of your business, and therefore 5% of any future profits made. It can take a number of forms, from close partnerships and angel investors to crowdfunding platforms and venture capital firms. There’s even a possibility to use the public as a form of equity finance by listing on the stock market.

Equity investors will then receive a percentage of any profits made. The amount they get depends on their amount of stock. As a result, if you choose to raise money through equity finance, you don’t have to make repayments  — money is simply deducted from the profits alone. There can also be other types of agreements where royalties and other benefits are incorporated to entice early investors.

Equity finance — the positives

  1. Invested business partners

The major benefit of equity finance is that, by bringing in equity partners, you have others who have a vested interest in making your business succeed. Since getting their investment back is tied directly to your profits, helping your business flourish is in their best interest. An equity investor with a contact book full of influential connections can be your best friend in helping your business succeed.

  1. No debt to repay

The other key factor is that there’s no debt involved in equity finance. If you don’t turn a profit, then you won’t pay anything back. That means less risk for you and your business, but it comes at a cost…

Equity finance — the negatives

  1. Loss of control

The biggest downside with equity finance is the loss of control. As you’re giving away partial ownership of your company to an external party, you give up a degree of the decision-making power. Depending on your agreement and how much equity you give up, in some circumstances you could even be pushed out of your own business, if results aren’t up to scratch. 

  1. Sharing profits

Furthermore, as well as splitting profits, you may also have to give profits to investors before you’re able to start making any money yourself.

  1. Time-consuming to set up and manage

In addition, getting equity finance can be incredibly time-consuming in comparison to debt finance. Without a solid pitch and the right connections, you could easily find yourself going nowhere, fast. Crowdfunding platforms have made the process easier, but there is no guarantee you’ll get the funding you need. 

As well as the initial time spent getting the funding, there is the ongoing task of managing your new shareholders, keeping them up to date and sharing profits accordingly. Debt finance, on the other hand, can be much quicker to obtain upfront and easier to manage overall.

What is Debt finance?

Debt finance works by borrowing money to fund your business from a lender. You then pay it back over time, as well as any interest or charges applied by the lender. Interest rates may be variable or fixed depending on the provider.

Types of debt finance include loans, lines of credit, credit cards and overdrafts.

Debt finance — the positives

  1. You keep control

Unlike equity finance,  you maintain control and ownership of your business. Ownership remains yours, you continue to make the decisions, and you don’t have to worry about being ushered out of the business if you hit a bad patch.

  1. It doesn’t last forever

Another major benefit is that, once the debt is paid back, your liability is over. If you can borrow only what you need and repay in a timely fashion, you won’t end up paying more interest than you need to. This can make it cheaper in a lot of ways than equity finance, where your future profits may end up massively outweighing the amount you might have paid in the interest on a loan.

  1. Tax breaks

Much more overlooked is that there are some tax deductions available for business debt, or more specifically, on the interest. While there are some criteria you need to meet to have access to these, it can create a positive impact on net profits while you continue to grow and yield positive revenues.

Debt finance — the negatives

  1. You have to make repayments

Unlike equity finance,  regardless of how well or badly your business is doing, you have to repay the debt plus any fees or interest. Depending on the loan you’ve taken, if you’re unable to repay then the lender could look to take any assets or guarantees used as security.

To help businesses only borrow what they can afford, at Funding Circle we assess your loan application based on your current performance. That way you’re not reliant on future growth to be able to repay the loan.     

  1. It can mix with personal finance

Another potential issue involves the combination of personal and business credit. Some business owners rely on both interchangeably, whether it’s credit cards, overdrafts or loans. As a result, problems in one area can impact the other, so be clear about where you want to draw the line and make sure you understand what could happen if you can’t repay. 

  1. Being clear about the cost of debt

It’s absolutely vital that you understand the terms of your finance. Depending on your provider, there may be additional fees you hadn’t accounted for, or if you have a variable interest rate your repayments could increase significantly. 

At Funding Circle all our loans are fixed-rate, so you know exactly what you’ll pay back each month. Our one-off completion fee is included in your monthly repayments, and there’s no fee if you want to pay off your loan early in one go. 

Too much debt could also impact your business’ profitability and valuation, which could make it harder to get equity or debt finance later on. If you choose debt finance, it’s wise to carefully consider how much is necessary to finance your objectives, and only borrow what you need. It could spare you from greater issues further down the road.

If you’re looking for fast, affordable finance, check your eligibility for a business loan in 30 seconds at fundingcircle.com/businesses.