How should I compare securing a bank loan to equity investment?
I’ve secured a £500,000 bank loan for expansion, but I’m worried about making the repayments if I don’t immediately see a return on my investments. Perhaps, I’d be better off seeking equity finance, but my advisers say I’ll end up paying more in the long term. Is debt finance the best option for my business?
A. Christopher Jenkins of Wingrave Yeats writes:
As Confucius says, “It depends…” Like most things in business it depends on your attitude to risk. Bank finance is by far the cheapest form of funding for a successful business, but it’s risky. Give away 20% of the equity of an early stage business worth half a million and it may only cost £100,000, initially. However, if it grows to be worth £5m, the value you will have given away will be £1m. That’s expensive.
Only one thing will cost you more: the failure of your business. And businesses usually fail because they run out of money. If equity funding allows you to expand your business quickly, safely and without the constraint of cash, then I would suggest that was a pretty good deal too. The overriding consideration for you here is to fund your business properly, so you can execute your business strategy efficiently.
Second, think of your sources of finance as stakeholders in your business. Will they play a valuable part in helping you achieve your objectives? Banks can provide valuable specialist expertise and shareholders, if they have sector-specific knowledge and can make a real contribution. So choose your partners carefully. Their attitude and support are far more critical than the terms of their investment.
Most businesses don’t make an “either or choice” between debt and equity. Having found an investor, it may also pay to take on debt as well.
Just because the bank has said yes don’t rule out looking for equity later on. If the bank has lent you enough to carry out the first stage of your plan, then you will have been given the chance to create substantial value without having given away your precious equity. The “price” of your shares will therefore rise dramatically in these early days.
Go to an investor once the value in your business is proven and for the same amount of funding you will probably have to give away only a fraction of that 20%.