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Equity or debt - which is right for your business?

Author: Business Finance Guide

Published: 01 Jun 2016

Whether to chose equity or debt finance is one of the first questions that business owners need to tackle. Explore the differences, the benefits of each and other considerations.

What is the difference between equity and debt?

Raising equity finance means selling a stake, or shares, in your business, while debt finance, in its simplest terms, is an arrangement between borrower and lender. 

Equity financing can be raised solely from existing shareholders, through something called a “rights issue”. Alternatively, equity can be sold to third-party investors with no existing stake in the business. Often these investors will provide more than just capital. For example, they may take an active role in one or more aspects of how the business is run.

In debt financing, a capital sum is borrowed from the lender on the condition that the amount borrowed is paid back in full either at a later date (a bullet repayment), multiple dates or over a period of time. Interest is accrued on the debt and the business’s repayment usually has an element of capital repayment and interest.

Which is right for your business?

Deciding whether equity or debt is the right solution is incredibly important and depends on where the business is right now, and what it is trying to achieve in terms of growth.

Equity investment is usually appropriate where a business is considering significant future growth. Given that growth there tends to be more risk involved in the investment decision.

Equity might be important because it is a riskier piece of the business development and that will typically involve giving a piece of ownership of the business.

One of the benefits of equity is that the providers often add additional knowledge and advice to the small business and help them to develop a growth plan.

One of the key considerations in taking on debt is that the business feels able to service the interest payment and repay the capital. So understanding cash flow and future cash flow development is key.

For early stage businesses, yet to deliver a profit, debt finance may not be an option. This is often where equity options can play an important role in supporting plans for growth.

Next steps

Finance at every stage

Business financing is not a one-off decision, but an ongoing and evolving situation. No decision can be made in isolation to the businesses journey. Find out more about what options are suitable now and what might work at another stage.

Business Finance Guide
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