Why debt now trumps equity for growing firms

Reece Tomlinson, MBA, CPA is the founder of RWT Growth Inc. an investment banking advisory firm that focuses on M&A transactions, helping companies access capital via debt and corporate advisory. He is an expert in helping growing companies secure finance and here, discusses why debt is more attractive than ever for tech companies.

“For growth stage companies, particularly tech companies, the known path to accessing capital is this; go out and raise money by giving shares away in the process. It’s a simple premise and it works. The majority of tech companies will utilise some form of seed, angel and venture funding in their lifetime. These capital sources serve a purpose and the ability for tech entrepreneurs to access the capital they need via equity financing worked well.

The majority of business owners we speak to are under the opinion that debt financing is all but shut down in today’s economy. Whilst the landscape may be more challenging then ever, we are seeing tech businesses get lending deals across the finish line. Here are five big reasons why:

1. The economy has fundamentally changed the way people are consuming products and how businesses function. Tech enabled businesses with strong margins, recurring revenues and easily scalable operations are generally not bound by geographic footprints and can grow exponentially with a lower marginal cost.
2. It is important to note that lenders are not motivated to take risk. Their mandate is to make the highest possible return on the lowest possible risk. Historically, tech businesses were perceived as more risky than traditional businesses and were shied away from, however thanks to COVID-19, tech enabled businesses now represent far less risk to lenders then those that do not.
3. As a whole, tech businesses generally have a lower amount of debt on the balance sheet then traditional businesses. This makes them more agile in an unpredictable economic environment.
4. Private lending is a booming asset class, which has seen a massive influx of capital since the onset of COVID-19 by family offices, funds and private investors[1] alike who are now eager to find deals and are, in some ways, directly competing with chartered lenders[2] for mezzanine and subordinated debt.
5. Lenders have finally begun to understand how tech business models work and many now have lending programs specifically designed for companies to leverage ARR and even users.

All of the above does not mean lenders are simply just giving money out. Lenders have more reason to be weary today then anytime in the past 90 years. Therefore, in order to have the highest chance of success acquiring capital from a lender, businesses need to; provide finely tuned lending packages that meet the criteria of lenders, demonstrate how the company will manage risk in this COVID-19 environment and indicate how the company will remain a going concern in both the short and long-term.”