Keeping track of your funding options | Female Leaders Series

Mar 22, 2019 / Ambition Nation Blog

The next instalment in our popular Ambition Nation: Female Leaders Series events, on 24 April 2019, is called ‘On Track’

The next instalment in our popular Ambition Nation: Female Leaders Series events, on 24 April 2019, is called ‘On Track’ for a reason.

For founders, running a company is a full-time job; scaling a company on the other hand requires a completely alien skillset you often learn as you go. What we’ve found from our conversations with female founders over the course of the Ambition Nation: Female Leaders Series thus far, is that ambitious entrepreneurs don’t have time for endless training sessions on their ever-expansive journey to win investment. They need practical, practicable advice on making the right funding decision, and they need to know when they’re on track to do so.

At any one milestone on the growth journey of a business, a founder will need different forms of investment, depending on their specific needs at the time.  Within the constant melee of running a business it’s easy to lose sight of the road in front of you, knowing when you’re about to hit those key decision points.

According to Beauhurst, there was a slump in both size of investment and in terms of deal numbers across the board in 2018; it was as ever female-founded companies that suffered more than their male counterparts – only 16% of 2018’s equity deals went into female-led businesses, that compared with 18% in 2016.

This perhaps tells only part of a story, as the right funding decision relies on more than just how much equity you’re willing to part with. How you know you’re on track often relies on slashing your way through an undergrowth of jargon when really you just want to know what your options are.

What are your options?

Generally speaking, funding options boil down to two financing routes – equity and debt. Find out more about these options in more details using our handy guide.

Debt involves borrowing money from an external source with a commitment to repay it over time, with interest. Equity financing is where you raise money by selling individual shares in your company.

Business owners who choose equity finance don’t repay the money with regular instalments as they do with debt; instead, the individuals or institutions become shareholders – partial owners – who are entitled to a portion of the business profits for as long as they hold those shares.

What’s important to know about whether you’re on track or not is weighing up the pros and cons of each type of financing.

Many companies will be financed by both debt and equity. There is a clear hierarchy between these two forms of financing, which is called the “capital structure.”

Basic capital structure

The hierarchy dictates which parties are paid when. This is important in terms of both regular payments (for example, repaying interest on debt, and paying out dividends to shareholders from annual profits) and also if the business is liquidated at any point.

The basic “chain of command,” from first priority to last priority, looks like this:

Financing type

Regular payments you need to make

In the event of default or liquidation

Senior debt or secured debt

Either a fixed or a variable rate as interest (agreed at the time you take on the debt)

First in line to have their capital returned (i.e. the principal amount repaid to them)

Preferred shares

A fixed rate as a dividend (agreed at the time the shares are issued)

Second in line to have their capital returned (i.e. what they paid for their shares)

Subordinated debt or junior debt (mezzanine)

Interest (at a higher rate than senior debt as riskier to the lender – they may not get their money back if you default)

Third in line to have their capital returned (i.e. the principal amount repaid to them)

Common shares

Possibly dividends, but often these are not fixed as they are for preferred shares – so you may not choose to pay dividends on these shares

Fourth in line to have their capital returned (i.e. what they paid for their shares)

 

Debt vs equity: Pros and cons

 

Pros

Cons

Debt

Because the lender does not have any claim to equity in the business, debt does not dilute the owner’s stake in the company

Debt needs to be repaid at some point

The lender is only entitled to repayment of the loan (plus interest), and has no claim on any future profits of the company. This means that if your business is successful, you will reap a larger portion of the rewards than if you had sold shares to investors in order to finance the growth

The interest that you must pay is a fixed cost, which raises your break-even point. Companies that have taken on too much debt can find it difficult to grow because of the cost of “servicing” the debt (paying the interest)

Interest on the debt can be deducted on your company's tax return, lowering the actual cost of the loan to you

Debt instruments often contain restrictions on the company's activities (which are called “covenants”), preventing management from pursuing alternative financing options and non-core business opportunities

You are not required to send periodic mailings to large numbers of investors, hold periodic meetings of shareholders, and seek the vote of shareholders before taking certain actions

You are usually required to pledge assets of the company to the lender as collateral, and owners of the company are in some cases required to personally guarantee repayment of the loan

Equity

Pros

Cons

Equity does not need to be repaid

Issuing shares means selling part of your ownership of the business

Common shareholders are not guaranteed a dividend, so there is no fixed cost for you to cover; if you haven’t made sufficient profit during the year, you do not have to pay a dividend. Preferred shareholders do have a fixed dividend rate, but if you have not made a profit then you are not obliged to pay it that year (unlike interest payments, which need to be made regardless of profit levels)

All shareholders are classified as investors and are therefore entitled to a portion of the rewards if your business is successful. If you manage to grow profit, they will expect dividends to be paid out consistently with no foreseeable end date (unlike debt which has a “maturity date” by which it must be repaid)

Equity is likely to be less restrictive than debt, which comes with “covenants” (restrictions on the company's activities)

No tax reduction available akin to what is offered for debt interest, and some share classes will come with conditions or caveats

No requirement to pledge assets of the company as no “collateral” required

Administrative requirements such as sending periodic mailings to large numbers of investors, holding periodic meetings of shareholders, and seeking the vote of shareholders before taking certain actions

The equity investor is fully aligned with your business objectives and is incentivised to help you grow

You may not be able to make strategic decisions without consulting them. This is a partnership – which can mean both good and bad elements for you!

 

Get the right advice

Weighing up these pros and cons is usually a challenging process for any company seeking growth capital, and what is right for one business will not be right for another. You should seek impartial, professional advice to help you assess the options available to you and make the right decision for your business.

Whether you choose to raise equity or debt – and knowing when the right time is for either – the process is typically a long one, taking several months.

Professional, impartial advice is critical to getting the best deal for your business, and that’s where finnCap Group comes in. We are dedicated and perfectly placed to support our brightest female entrepreneurs, to deliver their ambitions.

To register your place at the next Female Leaders Series event on 24 April, please email events@finncap.com