Smart Funding Choices: A Guide for Business Growth
Daniel Blair
Mid-Market Strategic Growth Specialist ??Business Funding Specialist ?? Business Optimisation Consultant ??
It is essential for entrepreneurs, founders and companies seeking to expand their operations to understand the various sources of funding available for business growth. Each funding option presents its own unique set of advantages and disadvantages, which can have a significant impact on ownership, control, and financial stability. In the following discussion, we explore the various sources of funding.
Debt financing involves borrowing money that must be repaid over time, usually with interest. Common forms include bank loans, credit lines, equipment financing, trade credit and convertible debt (‘convertible notes’).
Pros: Interest payments on the debt are typically tax-deductible, lowering the true cost of borrowing. Debt provides funding to accelerate growth. Debt financing does not dilute ownership, and therefore, founders retain full control over the business.
Cons: Interest payments are immediate costs facing the borrower and may increase the pressure on cash flow. Debt structures often require security including possible recourse to the individuals associated with the company. They also often include restrictive covenants that may restrict options for the company (e.g. restrictions on dividends and/or use of the funding) and may even extend to the individuals associated with the company. Debt also has higher seniority (priority) to Equity and can greatly increase financial risk and hence complicate the sourcing of future funding.
Equity financing involves raising capital by selling shares in the business. This can come from a number of sources including venture capitalists, private equity, corporate investors, angel investors, high-net-worth individuals, public offerings or even entities close to the founders (sometimes referred to “family, friends and fools’).
Pros: Equity has no term component and therefore no repayment pressure unlike debt. It is typically seen as a long-term form of funding from investors who are supportive of the vision/strategy for the company. Companies are typically free to use the equity for any purpose (albeit some capital raises are for explicit purposes) and the benefits of the funding can be reinvested into future growth or maybe paid out as dividends to shareholders. Additionally some investors may bring valuable industry knowledge and connections that could assist the company.
Cons: Equity means giving up a part of ownership and potentially even some control (and/or decision-making power) if the investor represents a significant portion of the overall shareholding. Another consideration is that additional equity funding expands the shareholder base and therefore dilutes both the ownership percent held by existing shareholders and diluted earnings and dividends.
Bootstrapping technically Equity refers to funding a business solely through personal funding from the founders of the business.
Pros: Founders retain full ownership and control over the company and its decisions. Typically this doesn’t dilute the shareholding base (of founders) nor does it increase the funding costs associated with debt.
Cons: There might be limited funding available and this can limit the options for growth and expansion. It may also expose the founders to the cost of failure, should the entity fail, as effectively all their eggs are in one basket.?
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Grants are payments that do not need to be repaid, allocated by governments or private organisations, typically provided for a specific purpose, sector and/or initiative.
Pros: Grants are effectively a free source of funding with no finance cost (ie interest) nor any dilution impacts (ie as is the case with Equity). Grants may also open doors into the grant maker (whether Government or Private) which can be beneficial for expanded relationships and/or sources of expertise. [footnote - while not grants, it is worth understanding the benefits of Research and Development tax incentives].
Cons: Access to Grants can be competitive given they are seen as free sources of funding. Grant applications often include stringent conditions and can be confusing and admin heavy processes to apply. Grants often require co-investment requiring the company to invest alongside the grant-maker. And Grants have compliance and reporting procedures to ensure that money is utilised for its intended purpose.
Last, subject to the tax jurisdiction, the Grant may be seen as a source of revenue and therefore have accounting and tax implications.
Choosing the appropriate funding source is critical for a business and will depend on a number of factors including its size, life stage, existing funding sources and its growth prospects. At LTV Partners, we work with our clients to define their current funding position (‘capital stack’) and what is required in the future to optimise their chances for success. Typically, a company should have a mix of funding (a mix of Debt and Equity). We are fortunate that we have funding partnerships across all sources of funding and therefore can access funding required for our clients. In future articles, we will provide detail on these funding sources including our partnerships. If you would like to know more, then please reach out.
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