Why does it have to always be a choice between debt and equity?
The benefits and challenges to both debt and equity and how they can compliment each other
When companies need financing, the MAIN question is equity or debt? Of course, there are also hybrid forms like convertible debt, and sometimes financing will be a combo of equity completed simultaneously with debt. Sometimes debt won’t even be an available option, particularly for smaller businesses without enough steady revenue or track record for a traditional lender to rely on for assurance of payment.
A standard bit of advice you’ll hear is that equity is the most expensive form of financing, meaning you should opt for debt when you can get it. Here’s an example illustrating the point. A company needs $500,000 in financing and is valued at $5 million post-investment. Imagine a basic choice of selling 10% of the equity in the company to raise the $500,000or borrowing that amount as a loan. Suppose further that the company does very well after taking the funding and is sold two years later for $15 million. The cost of the bank loan would be relatively modest – two years of accrued interest on the $500,000, which is tax-deductible. But for equity, the “cost” is a much higher$1.5 million, which would have otherwise gone to the founders!
Of course, this is a cherry-picked example that shows a stark difference, but it’s also a happy example for the founders because their equity increased in tandem with the investor’s equity. Suppose that instead of success, the company’s sales declined sharply after the financing. As a result, if the company had obtained debt financing, it would find it difficult to meet the monthly payments, raising the risk of bankruptcy. But with the equity financing, involving no ongoing payment obligation to the investor (assuming it’s not preferred equity with cash dividends, which is more debt-like), the company has more time and freedom to weather the storm of the sales decline and potentially recover at a later date. So, in this example, if debt triggers bankruptcy, it’s certainly the more “expensive” form of financing.
The point is that both debt and equity come with their own unique challenges. Traditionally, a company looking to grow has been required to make a trade off between ease and size of finance available for growth and its associated cost. It is a constant struggle to find the best way to unlock growth potential whilst maintaining balance sheet strength and maximising ownership.
Fundabl understands this conundrum and strives to offer a capital solution that allows clients to bridge the gap to greater value. Our solution works in tandem with the traditional finance offerings in the market to help you grow or take advantage of immediate opportunities.
Our Fundabl solution ensures:
1. Quick turn-around …. tick!
2. No equity dilution takes place for business owners…tick!
3. Companies receive certainty of capital to accelerate growth…tick!
…. A founder-friendly experience!
Finally, a product built for companies and businessowners looking to grow and maintain their ownership position and benefit from what they have worked so hard to build.