Equity vs Debt Financing: What's Right for Your Business?
When raising money for your company, one of the first decisions you will face is whether to pursue equity or debt financing. As a simple reminder: equity is money received in exchange for selling shares in your company, whereas debt is money borrowed that you will eventually repay.
What is right for your business will depend on the specific terms of any financing you are offered. The following sets out the key pros and cons of each to help you think it through.
Equity Financing
**Advantages**
• No need to repay the investment. The investor takes on the risk.
• There are usually no interest payments or regular repayments, which puts far less pressure on the company's finances.
• Investors may be eligible for EIS relief, which can make your raise more attractive to certain individuals.
• Investors can bring hands-on support, networks, and connections.
**Disadvantages**
• Dilutes your shareholding. You are giving up a slice of your business and, with it, a share of future profits.
• Dilutes your control, which can complicate decision-making.
• Investor consent rights can be onerous. Even where you retain a majority share, you may be required to obtain express consent before making certain business decisions.
• Investors may request a board seat.
Debt Financing
**Advantages**
• Does not dilute your shareholding or your profit-share.
• Does not dilute your control with regard to shareholder votes.
• Lender consent rights are generally less onerous than investor consent rights.
• Interest payments are tax deductible.
**Disadvantages**
• The total debt must be repaid before any sale proceeds are available to shareholders on an exit.
• Interest is usually payable on a monthly or annual basis.
• Returns for the lender are limited to the principal plus interest, so lenders have less upside incentive than equity investors.
• The lender may require security over company assets or personal guarantees from founders.
• Debt financing does not offer EIS relief.
Which Should You Choose?
Equity is more common for early-stage start-ups. Venture debt tends to become more viable as a company grows and, in particular, where founders need to raise capital without diluting existing shareholders, and are comfortable meeting repayment obligations.