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The information contained in this article is for information purposes only and is not intended to constitute legal advice.
This article is the first part of a series on raising finance. This article seeks to set out in brief how to facilitate the growth of your business and take it to the next stage by setting out some of the options for funding that may be open to you and the associated implications and trade-offs relating to that type of funding. Subsequent articles will explore debt and equity finance in greater depth.
Investing in your business; the context
You, as a business owner, may want to raise capital to fund a particular project designed to increase the future cashflows of your business. For instance, this could be through investment in up to date and efficient plant, machinery or technology which require an initial outlay of funds with the hope of increasing cash flow down the line and improving profitability. What are your options for achieving this funding?
You could opt to approach your bank for a loan. In this instance and if the bank is willing to provide you with the funding you require then your company and the bank will enter into a Loan Agreement. The Loan Agreement has extensive scope for negotiation as it is essentially governed by contract law, meaning the parties can enter into whatever bargain they wish. The key concepts that the bank lender may look to use to protect its position may include the following:
- Taking security
The lender will register a charge against the assets of the company, meaning that if the borrower does not meet the loan repayments, the lender can claim the secured asset in question to recoup what it is owed.
- Debt covenants
There are certain legal promises given by the borrower in relation to how the business will be run after the loan has been granted. This will protect the lenders position as they can then take comfort knowing that the business will be run in a way that will ensure the loan is able to be repaid.
A key advantage of debt finance is that the actual ownership of the business is retained by the business owners as there is no equity given in return for the loan. However, a key drawback of debt finance can be the lack of flexibility available in the loan repayments. Often it is the case that the repayments must be made at the agreed time irrespective of the success of the business.
Alternatively, it may be preferable for your business to raise finance through allotting new shares to investors in return for their investment. Similarly to debt finance, investors will look to certain terms to protect their position in the Investment Agreement. However, the key difference with equity finance is that when you allot new shares to investors, they become shareholders of the company and your ownership is therefore diluted. However, an advantage of raising capital via equity finance is the flexibility in the repayment of the investors. The repayment of the investors via dividends is dependent on the success of the business, meaning that the business does not have to pay out if it is not operating successfully, this can lessen the chances of an insolvency. Another advantage is the value which outside investors could add to the business. Often investors will have an interest in various other companies and can therefore offer their expertise as to how to grow your business.
When deciding whether to opt for debt or equity to finance your business growth and raise capital, you should think about your long term business plan and goals. It may also be the case that your business opts to start off by raising debt finance and then later down the line, in a subsequent funding round, opts to bring in equity investors.