Equity or Debt?

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You may be thinking of starting your own business or you may already be the proud owner of a young trading business. This article takes a look at some of the psychological and emotional factors behind deciding whether to go the equity or debt route if you need funding to get the business off the ground or to progress it.

There are many sources of reference that explore the more technical aspects of how to finance a business and the difference between debt and equity funding. Not many Ive seen actually tell you what you might expect once youve got the funding. This therefore is an insight into what your banker or business angel is expecting of both you as an individual and the business.

Lets start by saying that debt providers, (lets call them bankers for ease), and business angels are very different beasts. As a generalisation, bankers tend to play things by the book and very much rely on figures and ratios to drive the funding relationship.

Business angels on the other hand invariably take a far less functional view and are more interested in product potential, market opportunities and management drive. Remember though that, just as there are some (rare) genuinely commercial accountants and solicitors out there, so there are bankers! Likewise, Ive met some angels who work in a far more regimented fashion than any banker Ive ever met so bear in mind that this article is only a generic overview.

So what will they actually expect of you?

Lets take bankers first as this is more straightforward.

Your average banker is constrained by the organisation he works for. Lying behind the relationship manager who is the face to the public lies a plethora of committees and divisions, such as a credit committee, whose main role is to ensure the banks risk and exposure is minimised. They will usually lend to you only after fairly stringent personal and financial checks have been passed and any monies advanced are secured, often by way of personal guarantee.

The implication is that funds advanced to you by the bank are considered to be at pretty low risk. This should, in fact, be reassuring to yourself as, just as the bank are, you should be fairly certain that repayments can be met.

The flipside to this is that the bank get an awful shock if, for whatever reason, you cant keep up repayments! To avoid this type of scenario, the bank will normally demand the provision of financial information on a monthly basis. They may also have imposed financial covenants as part of the lending criteria. Failure to either provide the accounts on time or to breach the covenants usually leads to a rapid change in the banking relationship!

In summary, whatever bankers may say about looking at businesses from a commercial perspective, the whole nature of the relationship is still most likely to be driven by the Balance Sheet view, i.e. what the cold, hard figures are telling them.
Conversely, there can almost be a notion of romance about the approach from angels!

Angels tend to be wealthy individuals who have made money from selling their own businesses and who then like to keep their hand in by helping small businesses requiring funding. More and more often, sleeping angels are being replaced by angels who want to be active in some capacity in the business, often as a non executive director. Their experience can prove invaluable in this regard although it can prove disconcerting to have someone looking over your shoulder!

Of course, as its their personal money involved, some angels can be more demanding than the strictest of bankers. This is not usually the case though. Most angels are well aware that making a business successful requires the taking of risks, and will be a rollercoaster of ups and downs. Their biggest concern is what they refer to as the BDM factor – they perceive that potentially the biggest problem for a small business is a major birth, death or marriage related event affecting the key player(s).

As you would expect, there are some definite "no, nos" in the eyes of business angels.

These include:

- the owner using the recently injected funds from the angel to increase his/her remuneration

- an increase in non essential expenditure, e.g. office refurbishment, introduction of staff benefit schemes

- failure to notify the angel of potential problems when they arise, e.g. loss of a major customer, bad debts

- not having adequate financial controls and systems

- not putting in effort over and above the call of duty

So, what do we conclude from all this? Its best not to need any external funding in the first place!

Brian Green is a founding director of Continuum Limited, a firm specialising in providing accounting, financial and advisory services to the SME sector.

Brian can be contacted directly on 07970 687252 or by e-mail at brian.green@continuum-ltd.co.uk

Brian Green
http://www.continuum-ltd.co.uk