#SME&U

15 Mar 2020

Equity or Debt: How Should You Grow Your Business?

by RAKBANK
equity-or-debt-how-should-you-grow-your-business

Your business is poised for significant growth. Like any growing business, you need money to make money i.e. capital.

 

 

There are two ways to raise funds: debt or equity. Debt financing involves taking a loan from a bank. Another way is equity financing i.e. you sell shares to investors for cash and the investor with the chance to make a high return over time, when those shares are resold, or your company gets acquired or listed in the stock market.


 
Equity financing might be the right if you are at the early stages of your company or believe there is high risk with potential for rapid growth but don't have sizeable revenues or not profitable yet. Here, you are raising capital by selling a piece of your business to angel investors, crowdfunding sources, institutional investors like venture capitalists (VC) and private equity (PE).

 


The percentage you give up is based on the amount raised, valuation of the company, and market comparables, except in case of angel investors, any formal fund-raising takes months and difficult. You are pitching against hundreds of similar companies to a limited pool of investors.

 

 

Not all investor pitches materialize into term sheets or investments - in fact only a small percent do. It's also not uncommon for entrepreneurs diluting their equity and going into minority share (less than 51%) to appease investors.

 


The good part is you can get to grow, even if your business is at the formative stage. The downside is you are giving up some ownership and opening your business to outsiders for review. For the investor, he/she can benefit only if the company is thriving.

 

 

Increasingly, investors and entrepreneurs are working on a 'convertible loan' - a type of short-term debt that is converted into equity shares later. Making such an investment, allows the investor to receive a discounted share price based on the company's future valuation.


 
The other option is debt financing - here you must have clear visibility to the profitability, cash flow, realistic forecasts and ability to repay with interest charges. A bank will expect your company to be in operations for at least 1-2 years; 6 months of bank statements, office and revenues before consideration.

 


The pros are that you retain full ownership. Moreover, if you successfully repay, then you would have grown the company without giving away any share of your business. You can also repay/settle the loan early and reduce overall interest charges. Of course, the bank doesn't get involved in your operations, Board or decision making.

 


However, debt financing includes both secured and unsecured loans. Security involves a form of collateral, like a deposit, property, gold as an assurance the loan will be repaid. If the debtor defaults, that collateral is forfeited to satisfy payment of the debt. If it's unsecured, the interest rates are higher, and loan amounts are lower. This also carries a personal legal risk in the case of defaults.


 
The downside is the risk with borrowing capital, if you operate in a volatile market or your customers don't pay on time then you carry the burden of interest on loans and struggle to repay every month.

 

Within debt financing, there are options - all serve different needs and use cases.
 


One option is a credit card, where you borrow smaller amounts on your available credit limit but expect to repay that within a month. If repaid, there are no interest or fines. Else with interest rates from 2-4% per month plus charges, this can be expensive.

 

 

Then there is term loan - this is like a mortgage, where you borrow full capital and repay throughout the term of the loan, from 1 to 5 years.

 


 
Another way is a line of credit, which depends on how mature your business is to qualify. It can be used for stocking up on inventory, smoothing payroll expenses. It is also a cheaper financing compared to borrowing on your credit card.

 

 

Similarly, overdrafts, invoice, LPO, cheque factoring or discounting is useful when you have sales orders but need working capital. For instance, you won a contract to sell into a department store and need to pay suppliers an advance, but your client pays after 30 to 90 days. In such a scenario, with invoice financing the bank pays most of the invoice value upfront and takes a small percentage as its service charge or commission.

 

 

Merchant finance is a loan tailored to businesses that accept credit cards - like retail stores. In this, you can borrow, and the lender will take a fixed percentage of daily credit card receipts. So, on a sound business day, the lender takes in a more substantial amount, while on a slow day, the lender takes in a smaller amount of the loan as repayment.

 

 


More than ever, SME owners can utilize a variety of financing resources, including debt and equity. Deciding whether to finance your venture through loans or by giving shareholders a stake has long-term implications. Weigh your options carefully and consult with a Lawyer or Accountant before making this decision.

 

 


Tags :




Equity or Debt: How Should You Grow Your Business?

15 Mar 2020

equity-or-debt-how-should-you-grow-your-business

Tags :

Your business is poised for significant growth. Like any growing business, you need money to make money i.e. capital.

 

 

There are two ways to raise funds: debt or equity. Debt financing involves taking a loan from a bank. Another way is equity financing i.e. you sell shares to investors for cash and the investor with the chance to make a high return over time, when those shares are resold, or your company gets acquired or listed in the stock market.


 
Equity financing might be the right if you are at the early stages of your company or believe there is high risk with potential for rapid growth but don't have sizeable revenues or not profitable yet. Here, you are raising capital by selling a piece of your business to angel investors, crowdfunding sources, institutional investors like venture capitalists (VC) and private equity (PE).

 


The percentage you give up is based on the amount raised, valuation of the company, and market comparables, except in case of angel investors, any formal fund-raising takes months and difficult. You are pitching against hundreds of similar companies to a limited pool of investors.

 

 

Not all investor pitches materialize into term sheets or investments - in fact only a small percent do. It's also not uncommon for entrepreneurs diluting their equity and going into minority share (less than 51%) to appease investors.

 


The good part is you can get to grow, even if your business is at the formative stage. The downside is you are giving up some ownership and opening your business to outsiders for review. For the investor, he/she can benefit only if the company is thriving.

 

 

Increasingly, investors and entrepreneurs are working on a 'convertible loan' - a type of short-term debt that is converted into equity shares later. Making such an investment, allows the investor to receive a discounted share price based on the company's future valuation.


 
The other option is debt financing - here you must have clear visibility to the profitability, cash flow, realistic forecasts and ability to repay with interest charges. A bank will expect your company to be in operations for at least 1-2 years; 6 months of bank statements, office and revenues before consideration.

 


The pros are that you retain full ownership. Moreover, if you successfully repay, then you would have grown the company without giving away any share of your business. You can also repay/settle the loan early and reduce overall interest charges. Of course, the bank doesn't get involved in your operations, Board or decision making.

 


However, debt financing includes both secured and unsecured loans. Security involves a form of collateral, like a deposit, property, gold as an assurance the loan will be repaid. If the debtor defaults, that collateral is forfeited to satisfy payment of the debt. If it's unsecured, the interest rates are higher, and loan amounts are lower. This also carries a personal legal risk in the case of defaults.


 
The downside is the risk with borrowing capital, if you operate in a volatile market or your customers don't pay on time then you carry the burden of interest on loans and struggle to repay every month.

 

Within debt financing, there are options - all serve different needs and use cases.
 


One option is a credit card, where you borrow smaller amounts on your available credit limit but expect to repay that within a month. If repaid, there are no interest or fines. Else with interest rates from 2-4% per month plus charges, this can be expensive.

 

 

Then there is term loan - this is like a mortgage, where you borrow full capital and repay throughout the term of the loan, from 1 to 5 years.

 


 
Another way is a line of credit, which depends on how mature your business is to qualify. It can be used for stocking up on inventory, smoothing payroll expenses. It is also a cheaper financing compared to borrowing on your credit card.

 

 

Similarly, overdrafts, invoice, LPO, cheque factoring or discounting is useful when you have sales orders but need working capital. For instance, you won a contract to sell into a department store and need to pay suppliers an advance, but your client pays after 30 to 90 days. In such a scenario, with invoice financing the bank pays most of the invoice value upfront and takes a small percentage as its service charge or commission.

 

 

Merchant finance is a loan tailored to businesses that accept credit cards - like retail stores. In this, you can borrow, and the lender will take a fixed percentage of daily credit card receipts. So, on a sound business day, the lender takes in a more substantial amount, while on a slow day, the lender takes in a smaller amount of the loan as repayment.

 

 


More than ever, SME owners can utilize a variety of financing resources, including debt and equity. Deciding whether to finance your venture through loans or by giving shareholders a stake has long-term implications. Weigh your options carefully and consult with a Lawyer or Accountant before making this decision.