When small and medium-sized enterprises SMEs attempt to secure Funding, some of the solutions can present difficult choices. One of these would be if a company offers finance in exchange for equity in your company.
Also known as “equity financing”, trading your blood, sweat and tears for a cash injection may not be the best idea for several reasons. Here are some of them:
Loss of ownership and control: By handing over equity, you’re surrendering a portion of your company. This may well dilute your control over business decisions, especially if the investor ends up with a large stake. Always remember, “those who pay get a say”. You’d be well advised not to take this as your first option.
Long-term profit sharing: Equity financing means the investor will share in the future profits of your business indefinitely. Over time, this could result in significant payouts compared to what you would owe on a loan.
Potential conflicts: External investors may have different goals or expectations to yours, possibly creating conflicts over the direction and aims of the business.
Pressure for growth: Equity investors often expect high returns, which could push the business towards rapid growth strategies that may not align with your vision. Speedy growth is not always good for business and agreeing to it could cause resentment should your business start flailing.
So, what are the alternative funding solutions you could try, rather than giving away portions of your business? Let’s look at what’s on offer and what pros and cons each brings with it.
Banking term loans
A term loan from a bank has a predetermined repayment schedule and a fixed or floating interest rate.
Advantage: You retain full ownership and control over your business.
Drawback: You are obliged to repay the loan at the agreed interest rate, even if your business struggles.
Business line of credit
This is a flexible financing option where a lender provides a credit limit and you can borrow as needed. You only pay interest on the amount borrowed.
Advantage: This option offers flexibility, allowing businesses to manage cash flow or fund specific projects without giving up equity.
Drawback: Interest rates can often be fairly high, and you must have a solid credit profile to qualify.
Crowdfunding
This is the process of raising small amounts of capital from a large number of people, usually through online platforms such as Kickstarter or GoFundMe. Crowdfunding is most often used by startup companies or growing businesses as an alternative way to access funds. Some crowdfunding operates on a donation basis, and the company does not need to pay back investors, but many companies offer incentives for early backers such as an advance copy of the product.
Advantage: With no need to take on debt or give up equity, crowdfunding can also serve as a marketing tool and determine interest in your product.
Drawback: Success depends on the strength of your campaign and product appeal – and not all projects get fully funded.
Venture debt
This is a type of debt financing typically available to venture-backed companies, where lenders provide capital in exchange for interest payments and often some form of equity kicker – think “warrants or options”.
Advantage: You retain more equity than you would with full equity financing, while still getting access to significant capital.
Drawback: You must still repay the loan, which can compound financial pressure.
Grants
Grants are funds provided by government agencies, non-profit organisations, or private companies that do not need to be repaid.
Advantage: Grants provide “free” money without the need to surrender equity or take on debt.
Drawback: Competition for grants is fierce, and the application process can be extremely time-consuming and complex, often needing an expert to ensure you get a shot at the prize.
Invoice financing
Invoice financing is where a company sells its outstanding invoices to a lender at a discount, receiving immediate cash flow.
Advantage: It provides a quick way to access working capital without taking on debt or losing equity.
Drawback: You don’t receive the full value of your invoices, and there may be fees associated with this option. Again, the wise SME owner would have a financial professional oversee this process.
Revenue-based financing (RBF)
With RBF, a lender provides capital in exchange for a percentage of future revenue until their investment is paid back, typically with a premium.
Advantage: Payments fluctuate with your revenue, which makes it somewhat less risky than traditional loans.
Drawback: It may work out to be more expensive than traditional loans, and you still need to have robust revenue to qualify.
Angel investors
Wealthy individuals who provide capital in exchange for convertible debt or equity ownership are known as angel investors.
Advantage: Beyond capital, angels often provide mentorship, business guidance and connections in various industries.
Drawback: While less formal than venture capital, you still give up equity and angel investors may well want a say in your business decisions.
Bootstrapping
Bootstrapping is the process of building a business from scratch without seeking investment or with minimal external capital, using your own savings, revenue from sales, or other personal resources to fund your business.
Advantage: No debt and you retain complete control of your company.
Drawback: Growth may be slower depending on funds available, and personal financial risk is high, especially if you re-finance your home or use a family savings account.
Whatever you choose, each of the alternatives listed here allows for flexibility in funding while helping avoid the long-term costs associated with giving up equity in your company.
Your best choice will always depend on your business’s financial health, growth stage and long-term goals. Again, if you can access a mentor or financial advisor, your chances of making the best decisions for your business and your pocket are vastly improved.
