How can taking on debt and equity accelerate growth in your business?
With a plethora of funding options available to businesses looking to grow and scale-up, it can be a challenge ensuring you are choosing the right option.
The two most traditional methods for funding growth are debt, typically in the form of a loan, or by giving away equity in your business in exchange for funding.
But what are the trends that business owners and commercial teams – operating companies between £1m and £50m – should know about? To help, BLM has spoken to the leading operators in this space.
What are the trends around taking on debt or equity that business owners should be aware of?
Alistair Hay: “The availability of different debt financing options has never been higher. They include challenger banks, debt funds, alternative lenders including Peer2Peer lenders, and crowdfunding as well as asset backed lending options.
“Interestingly, leverage levels are back at pre-financial crash levels but right now they are not exceeding previous highs. There are also some early signs of lenders restraining appetite to certain sectors such as retail.”
Angus Grierson: “At LGB Corporate Finance, we believe that 2019 will see a sustained rise in smaller companies using debt to fund their growth as investment opportunities widen.
“On the private equity (PE) side, record levels of dry powder have resulted in SMEs being able to secure higher valuations as PE firms try to secure the best investments for their portfolios.
“This is in contrast to public markets, such as AIM – the junior market for companies which has fallen by around 10% over the past year. In January this year, we saw a considerable slow-down in terms of secondary fundraisings and there were no IPOs, suggesting that at the smaller end, public markets are becoming increasingly jittery ahead of Brexit.”
What are the advantages of taking on debt to fund growth?
Stuart Andrews: “One of the key advantages of taking on debt to fund growth for a business owner is they do not have to dilute the equity in their business. That also means there is no claim from lenders on future profits over and above repayments on the debt obligations. It’s also an unobtrusive form of business funding.
“Meanwhile, there are tax advantages to borrowing rather than raising funds by giving up equity. Interest on debt financing is tax deductible whereas dividends to shareholders must be paid after tax so ultimately cost the business more.
“The Capital costs are lower too compared with equity loans.”
Andrew Ferguson: “There are many advantages to taking on debt to fund growth. Taking on debt can be cheap, utilising low interest rates and a wide range of lenders that can provide debt financing, in turn making it easier to find a suitable agreement.”
Angus Grierson: “Debt finance is relatively cheap at the moment. If your business is generating cash and profits, it is worth considering as it generally does not involve giving up any ownership in a business and in the long term it can therefore be more efficient for entrepreneurs. It is typically easier and quicker to raise debt than equity, but if used inappropriately it can be damaging.”
What are the advantages of using equity to fund growth?
Stuart Andrews: “Debt must be repaid whereas equity finance provides the business owner with a greater degree of flexibility albeit at the cost of giving up some control of the business. The contractual nature of the repayments obligations of debt finance will also by definition limit what a business owner may be able to do, whereas equity finance is, at least in theory, limitless.”
Andrew Ferguson: “The biggest advantage of using equity to fund growth is of course that companies are not subject to fixed re-payments. In turn, businesses have more flexibility to manage and allocate capital in the short term.”
Is there a stage in a business where debt is a better option and vice versa?
Alistair Hay: “Debt requires an element of visibility over a company’s revenues to service future obligations and therefore very lumpy or unproven revenue models are probably not well suited to this type of finance. Start-ups and businesses that haven’t made a profit yet are very difficult to leverage with traditional banking products such as term loans, revolving credit facilities or overdrafts.
“For a business with earnings below £1m EBITDA (Earnings before interest, tax, debts and amortisation) would probably have to rely more upon trade finance and asset-backed lending solutions such as invoice discounting.
“If a business had sufficient scale, earning above £1m EBITDA, and has the ability to operate within required controls and covenants, then debt may be the preferred funding option to equity as it is cheaper and the business owner doesn’t concede control of their company through equity dilution.”
Stephen Sacks: “The question is far more complex than deciding between debt or equity nowadays since there is a morphing between the two in the market.
“PE will load any equity deal with debt which the business will need to repay. There are also several venture debt players in the market who will offer high yielding debt with or without an equity kicker. Some deals can also convert from debt into equity upon hitting deal milestones or visa versa.
“Motivated investors may offer capital that is equity or debt in name only but in reality is in effect a subsidy. These can be the most attractive deals of all. Sometimes they are also your potential exit.
“My advice would be to forget the traditional definitions of debt and equity and instead focus on finding motivated stakeholders who want to play a part in the future of the enterprise.”
What experiences have you had as a business owner, when it comes to funding growth?
Paul Swaddle: “When we started, we initially took some equity from friends and family. This was to get us going because at that stage we didn’t have the capital to launch the company.
“Later in our journey we also looked at debt financing to help the company grow and we undertook a round of a crowdfunding finance which we found surprisingly easy. However, that did come with the normal constraints of requiring personal guarantees from the directors.
“At a later stage we also utilised a bank facility that was underwritten by the government and that enabled us to access money that otherwise the bank would not have offered. But the course still came with personal guarantees.
“The last round of funding, two years ago, was equity and carried out via Seedrs. While the process was not without its problems it did offer us a route to finance but also gave us 400 shareholders who can become advocates and Ambassadors for Pocket App.”
Rob Shand: “Debt was a good route initially, when smaller sums were required and in shorter time frames. We found the non-traditional route to be far more compelling than secured bank lending, which was essentially unavailable. The banks have such a long way to go and are being left behind. To that end, we used crowdfunding through Funding Circle twice which was simple and quick.
“Experiencing rapid growth, we needed a more significant capital injection and arranged a seven-figure equity raise from a large Venture Capital team based in Berlin. The deciding factors were the size of the capital required and the shared vision for rapid international growth.
They understood what we were trying to achieve, were relatively light on due-diligence, kept the deal simple and have since stood back and let us get on with it without interference. So for a VC-backed deal, it has been the right path for us.
“Next stage deciding factors are now all about fit with our vision and brand and who can help us take the next step up in revenue and growth – all the way to exit.”