Too often, business owners face the dilemma of whether to go for debt or equity when it comes to capital-raising. Here's what to consider when making a decision that best suits the company.
You have a great business idea, and you are all pumped up to get it off the ground. But there is one big hurdle: capital.
No business can run without capital. In every venture, money helps to drive operations, paying for an office space, equipment, and wages. As such, raising funds is crucial for survival and eventual scaling. But finding financial sources can be difficult, especially for new or small businesses with limited profits.
There are typically two choices when it comes to generating funds: debt or equity. Here's a breakdown of the various types of financing and how they might work for you.
Maintain full control with debt capital
One way to get a business going is through debt financing. This is an easy way for small businesses to raise much-needed money while retaining full control.
Debt capital essentially means borrowing money to cover initial costs. Business owners should be aware of interest rates and various terms and conditions before agreeing to the loan, as defaulting on payments could incur financial or legal penalties.
Through government grants and unsecured bank loans, businesses have two affordable and convenient means to raise funds without offering their assets as leverage - which puts pressure on owners to turn profits quickly.
Bank loans and government grants
With lower interest rates than credit cards, traditional bank loans present an attractive option. They fund up to S$500,000 and have a fairly relaxed repayment period of one to five years, while interest rates range from 7 to 12 per cent per annum. There are criteria to fulfil before securing a bank loan, and the approved loan amount may not be the full sum asked for.
In addition, there are government-assisted loans schemes to turn to, including the SME Working Capital and the Temporary Bridging Loan Programme under Enterprise Singapore’s Enterprise Financing Scheme.
The Temporary Bridging Loan Programme was introduced in 2020 at the height of the COVID-19 pandemic, along with an enhanced version of the SME Working Capital loan, as the government shored up support for local small and medium-sized enterprises (SMEs). For example, a temporary bridging loan can be disbursed for up to S$3 million, with a repayment period of up to five years at Maybank.
Another debt capital option is to issue corporate bonds, which suits businesses that prefer securing long-term finances. So how do corporate bonds work?
Investors buying these bonds are effectively lending money to a business and banking on its ability to profit and repay them. Unlike going public and issuing shares, bond financing does not dilute the value of existing shareholdings.
As the bond redemption date is typically several years later, businesses retain more cash flow and have more time to become profitable. Owners can also leverage the bonds’ fixed rates, meaning they are shielded from the short-term fluctuations of interest rate hikes.
But there are risks. Companies must pay regular interest to bond holders regardless of their financial situation, which could drain resources during an unstable period.
Perhaps the most flexible debt option is to use a credit card. It is a fuss-free way to cover cash flow gaps and pay off short-term expenses, all without applying for a loan - a huge plus for businesses with more sporadic revenue.
In fact, some business credit cards also have perks such as rewards programmes that could benefit SMEs. One thing for owners to note: while using a credit card lets them spend beyond their means, they have to think carefully about their ability to keep their balance in check.
Greater safety nets with equity capital
For some companies, the money raised from debt may not be enough to realise growth plans. Much bigger investments are needed, and equity fundraising has that potential. It not only allows a business to fund a launch and survive, but also potentially scale to greater heights.
Angel investors and venture capitalists
Angel investors are named as such because they are typically seen as a godsend to those trying to grow their business quickly. Similarly, venture capitalists are another group who might sink money into businesses they believe could make a big splash.
Unlike a loan, invested capital does not have to be repaid in the event of business failure, giving businesses a crucial safety net to mitigate risks. However, as funds are supplied in exchange for taking an equity position in the company, owners have to cede a certain amount of control to their investors.
For those willing to do so, they can expect their new partners to have a say in how the business is run and to also receive a portion of the profits when the business is sold.
The other common equity route is to go public with an initial public offering (IPO). It is the fastest way to generate increased public awareness that may lead to an increase in market share for the company.
However, to launch an IPO, a company must be able to pay for the generation of financial reporting documents, audit fees, investor relations departments, and accounting oversight committees. Going public also takes time - anywhere from six to nine months or longer.
And once a company goes public, a lot more transparency and governance scrutiny are needed as it must answer to its shareholders.
Know what you are getting into
In all, there is no right method to finance a business. More importantly, owners need to know their business inside out and do their due diligence on the multitude of fundraising avenues available to find the best way. Being informed will give owners the best platform to succeed.