Is your business in need of additional funding or working capital for continued growth?
There are several different funding options available to companies, including debt and equity solutions. These include:
- Bank debt
- Raising private equity
- Raising private debt
- Debt/Equity hybrid structures
We look at the pros and cons of each one of these below:
1. Long Term Bank Debt
Pros
- Potentially a quick option to meet urgent liquidity needs, pending bank approval.
- Interest costs may be deductible against business profits.
Cons
- Since COVID-19, banks often require personal guarantees, and in that case, you will also have to think carefully about putting your personal assets on the line.
- Interest costs will still need to be paid, which will be a burden on the operating costs of your business.
Assessing the full spectrum of financing options available is important before jumping to the conclusion that long term bank debt is the best option to pursue. For example, an increase of an existing overdraft facility may be the best option to see your business through a drop in short term cash flow, rather than incurring an additional longer-term debt obligation.
2. Private Equity
Private equity is composed of funds and investors that directly invest in private companies. Equity in a business is exchanged in return for this cash investment, thus diluting the ownership of original founders and investors.
Pros
- Private equity will allow a business to avoid the cash flow pressures of having to repay loans.
- New investors may also add skills and experience to a business in addition to cash.
Cons
- Valuing the equity in the business can be challenging with recent comparable business transactions providing a less useful reference point than they usually would prior to COVID-19.
- For a number of investors, their appetite for risk has changed since COVID-19.
- As a result of the points above, equity may take extra time to source, including negotiation of the terms with potential equity investors.
3. Private Debt
Where a private investor(s) is acting in the role of a traditional bank by providing a loan to the company and receiving a yield in return which might be paid monthly or quarterly. Investors will generally get some form of security over the assets of the firm, or more interestingly, revenue (for recurring revenue businesses such as SaaS businesses).
Pros
- Businesses that may be unable to secure bank loans may still appeal to more risk-tolerant investors.
- Maintain equity/ownership in your business
- New investors may also add skills and experience to a business in addition to cash.
- Interest costs will be tax-deductible against business profits.
Cons
- Interest rates will typically be higher than bank interest rates.
- Business owners will normally need to offer security within the business or personal guarantees.
4. Hybrid Debt/Equity
This the most complex of the options available to your business, but potentially an opportunity worth pursuing for some businesses. Options include Convertible Notes and Preference Shares.
Convertible Notes
Convertible Notes are a form of short-term debt that often converts into equity, typically in conjunction with a future financing round, and normally at a discounted rate for the investor. Interest will also typically be capitalised before any conversion takes place.
Pros
- The valuation of a business can be delayed and be uncertain. However, normally a valuation cap will be negotiated to mitigate the risk for the investor.
- Interest will normally be capitalised.
- Generally fast to structure and take to market.
- Convertible notes (and versions of them) are becoming increasingly common in the New Zealand private markets, and we expect them to become even more so in the years ahead.
- Generally provides an effective bridging funding instrument for growth businesses.
Cons
- If not well understood or managed properly, convertible notes can add complexity and confusion to your cap table.
- For investors, a convertible note isn't as well understood compared to pure equity.
- Uncertainty around dilution remains until the next round is priced or the convertible note matures.
- Depending on the structure, the debt may have to be repaid rather than convert to equity.
Preference shares
Preference shares vary in style, but in general, they pay a cash interest rate to investors and are higher ranked than ordinary shares (but still behind other creditors and banks). They may also include an opportunity for the company to buyback, or be converted to ordinary shares at some point in the future.
Pros
- They are generally classified as equity, which has benefits for a company balance sheet.
- Likely to be some flexibility on interest repayments compared to traditional debt terms.
- Often flexible in terms of company buying them back from the investors.
- Depending on structure may be attractive to investors who want both a yield and the ability to convert to ordinary shares for capital growth in the future.
Cons
- Add a relatively fixed cost (interest repayments) to a business.
- Depending on the business and the economic environment, the rate of interest may be high.
If you'd like to chat about how any of these financing options might work for your business, please get in touch. We can talk to you about your options, and give you an update of what we're seeing in the market from private investors. We always encourage you to have these conversations sooner rather than later.
To organise a chat, email [email protected]
