Starting and expanding a new business can be an exciting venture fuelled by fresh ideas. However, obtaining funding for an SME can generate debt or leave you with reduced ownership. For example, equity financing is a common method that attracts many business owners as they generally do not need to repay the funding. However, issuing shares can significantly impact your business journey in the long term. This ownership dilution can affect your income and the level of control you have over your business. This article explores funding methods for small businesses or startups that can allow you to retain full ownership of your company.
The Distinction Between Equity and Debt Financing
Many new business journeys are funded either by equity financing or debt financing. The following table defines each option.
| Type of Capital-Raising | Explanation |
| Equity Financing | Giving equity means giving shares in your company. Shareholders will typically receive a percentage of profits, voting rights and the right to share in sale proceeds if you sell your company. An investor being issued with a material stake in your company may also request a seat on the board. Equity financing can come in many forms, including: + venture capital investment; + angel investment; and + equity crowdfunding. Equity financing carries the advantage of not requiring repayment. However, issuing shares also means a reduction in your level of ownership. This can impact your earnings and your influence over the business. |
| Debt Financing | Debt financing involves borrowing money to raise capital. With most forms of debt financing, business owners must repay the full loan amount plus interest. This form of funding would allow you to retain ownership. Disadvantages include that it can be difficult for some to obtain loans, and repayment reduces profitability. |
1. Friends and Family
Borrowing money from friends and family is a simple way of generating capital for a business. Ensure you are clear with them about repayment terms and that all parties fully understand the agreement. Even though the investors are familiar to you, it would be best to have a written agreement about the terms of the agreement to protect your relationship.
Often, friends and family are willing to be flexible with their investment, and they may not charge interest. However, this option is only feasible for some, and the amount friends and family can invest is generally limited.
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2. Bank Loans
Bank loans are a traditional form of business financing. Banks often loan money to startups and small businesses. To obtain funding, you must apply for the loan and await approval. Banks accept only some applications. Accordingly, your personal financial history and that of your business can impact approval.
As is typical with the other types of loans and debt financing discussed in this article, you will repay the total loan amount of a bank loan and interest.
3. Startup Loans
Startup loans are personal loans from a government-funded company that business owners spend on their businesses. Generally, startup loans can be more suitable for those who have difficulty applying for bank loans. These loans are for a fixed rate and term.
4. Crowdfunding
Many forms of crowdfunding allow you to raise capital for your business and retain full ownership. The method typically involves many backers donating small amounts into one pot; this is donation-based crowdfunding. If you were to reward backers for their donations, it would be reward-based crowdfunding. If backers loan the money through a crowdfunding platform and expect repayment, it would be debt-based crowdfunding. These three methods allow you to retain ownership and raise capital.
You would not need to repay the money with the donation and rewards-based crowdfunding as they are not forms of debt financing. Bear in mind that equity crowdfunding is a type of crowdfunding that involves issuing shares to investors. This form would leave you with reduced ownership.
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Debt Financing Considerations
The methods of capital generation we have discussed in this article are forms of debt financing. When taking on debt to start a business or a new business project, you should be clear about:
- what you are using the investment for;
- what it will generate;
- the impact it can have on the profitability of your business; and
- how you will repay it.
Key Takeaways
If you want to avoid the reduction in ownership that comes with equity financing, you may seek alternative financing methods to fund your new business venture. These can include the following:
- borrowing from friends and family;
- bank loans;
- startup loans; and
- donation, rewards, or debt-based crowdfunding.
Before seeking finance, clarify what you want to do with the money and seek professional advice. If you need advice about generating capital for your business, our experienced startup lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today on 0808 196 8584 or visit our membership page.
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