How Does Debt Finance Differ From Equity Finance?

With The Bank of England forecasting a 2% growth for the economy in 2017, companies will be grasping this opportunity to strengthen and grow their businesses and benefit from this rising economic activity.

Financing business growth to take advantage of these opportunities can present challenges, however, which is what we are looking at in this article.

Cash is king, or is it?

The cheapest form of business finance is of course through cash flow. As revenue increases, some of the profits can be used for re-investment back into the business to fund further growth.

Although no borrowing is required for this form of finance, it can hamper the ability of a business to respond quickly to market opportunities as raising funds is dependent on revenue and profitability.

This strategy is likely to create a business with strong foundations, although there are risks that its’ competitors can react more quickly, and grow more rapidly thereby undermining market share of the cashflow funded company.

Equity finance has a sting in its tail

You don’t need to watch many episodes of BBC’s Dragons Den to understand that borrowing money in exchange for equity can have a real sting in its tail.

Entrepreneurs and business owners who have great product ideas, or have worked hard to build a successful business from scratch must face giving away significant chunks of their business in exchange for investment funds from third party investors.

Raising equity finance can be beneficial as investors often bring related business skills, market knowledge and contacts into the business, which is why some entrepreneurs on Dragon’s Den are there to attract a well-connected “Dragon” with proven success and market clout.

Depending on the risk perceived by investors, they will demand significant share-holdings in exchange for their funding. This can be very painful for business owners, who are reluctant to dilute ownership of their business, even though its growth will be accelerated.

Debt finance is a good alternative – if you can find a lender

Ambitious business owners should ideally be looking to fund growth by borrowing from a lending institution which charges interest rather than demanding equity in exchange for the loan. Particularly if large sums are required where entrepreneurs may need a guide to help develop their lending strategy.

Business finance explained

This debt finance can be difficult to achieve and often comes with high interest costs, depending on how the lender perceives the business risks, but generally it’s much cheaper finance than equity.

High street banks are likely to be the first port of call, however they generally only lend to companies with low risk profiles and it can take considerable effort and time for a business to secure finance from these traditional lenders.

Statistics show that it can take 4-6 months for a bank to consider a business loan application, and then reject it, and up to 9 months for it to conduct its due diligence investigations to approve the finance.

When funding from these traditional lenders eventually arrives, it is free from equity demands, but the timescales involved can hamper a businesses’ ability to react quickly to market opportunities. Also, it is likely to be well established rather than entrepreneurial start companies that meet the traditional lender risk profiles any way.

Debt finance from specialist lenders

Fortunately for ambitious businesses, there are other lenders that take a different approach to business loans. Lenders such as OakNorth Bank, who are based in London, take a much more flexible and bespoke approach when considering business loans.

What makes OakNorth different from traditional lending institutions is that it was founded by entrepreneurs who experienced the hardships of obtaining business finance themselves. They decided to set up their own bank specifically to provide debt finance to businesses who may not meet the stringent requirements of traditional banks, yet exhibit considerable potential for future growth and prosperity.

Similarly to a private equity firm, OakNorth provides its borrowers with the chance to meet the Credit Committee (i.e. the decision makers) and discuss their businesses and lending requirements directly.

This “entrepreneurs lending to entrepreneurs” approach can dramatically shorten the loan application process – meaning that loans can be funded in a matter of weeks rather than the months required by traditional lenders.

Additionally, OakNorth will consider providing unsecured finance to businesses who can demonstrate strong cashflow and profitability, rather offering a loan secured on tangible assets such as freehold business premises or even the houses owned by the directors. It will also consider other assets such as intellectual property, debtors, stock, plant and machinery.

Businesses now have many options to fund their business plans

Business owners are fortunate that there are varied opportunities to secure business finance. It depends on the nature of the business, the market opportunities and the attitudes of the business owners, as to which funding mechanism is the most appropriate.

If giving away equity is unappealing and traditional banks are either too slow to react or are unwilling to lend to your business, it makes sense to consider banks such as OakNorth who specialise in business loans and take a transparent approach to give a decision in as short as time as possible.

This infographic summarises some of the benefits of debt financing with OakNorth Bank.

Infographic from Oaknorth Bank
Click for a larger image

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