25 August 2021

Is taking on debt or giving away equity the best way to fund growth?

LGB's CEO Andrew Boyle recently contributed to a debate in Business Lender's Money Supplement on the best way to fund growth. 

Debt

Benefits of selecting debt to fund growth (considering current context and economic climate)

Debt is a bridge to future cash flows. Companies facing short-term business interruptions or those expecting returns from capex or acquisitions can therefore consider debt as a financing option. Nevertheless, these companies should ensure they have an appropriate repayment profile for their businesses and balance sheet. Given the experience of the last 18 months, all assumptions about business performance should be tested rigorously before debt obligations are taken on. Short-term options could be using an overdraft or invoice discounting, while longer-term options might be a term loan of four to five years.

The principal benefits of debt are its relatively low cost and the avoidance of equity dilution. However, the choice of lender is important in case flexibility is required. The cheapest option or at least the one with the most certainty can be borrowing from a bank or credit fund. Companies can also turn to medium term note (MTN) programmes, which establish common documentation for multiple issues of notes to a diverse group of lenders. Companies can develop relationships with noteholders, who make independent investment decisions.

What are the trends shaping this space that businesses should know about?

To some extent, government assistance to companies through CBILS and Bounce Bank loans and through furlough and grant payments has crowded out private-sector lenders. Many credit funds are struggling to fulfill their mandates and banks are offering better terms. Companies that can present robust business models and strong management teams should be well-positioned.

Equity

Benefits of selecting equity to fund growth (considering current context and economic climate)

Equity capital is a reserve to be used to support a company through difficult periods and to fund capital investment when the pay-back period is uncertain. Companies that have experienced fundamental change during the pandemic or weakened balance sheets will require more than a bridge to expected cash flows. In such cases equity capital, rather than debt, would be appropriate. 

The key advantage of equity capital besides the absence of repayment terms is the ability to offer pricing that could be attractive in both positive and negative circumstances. Equity investors cover the full range of human characteristics, from those requiring certainty to those seeking high returns and being willing to take considerable risk. The important factors are a board’s honesty when making the proposition and its ability to identify investors for whom the investment is appropriate. A management team should not make a presentation if this has not been confirmed in advance.

What are the trends shaping this space that businesses should know about?

The pandemic has hurt some sectors such as leisure and travel, while it has caused capital to rush into other sectors, notably healthcare. Management teams should recognise the positioning of their businesses.  They should strengthen financial models in weakened sectors and find applications for their know-how in business areas that have a following wind.

Similarly to debt, monetary policy has increased the surplus of capital available for investment in equity. The prospect of tax rises is supporting fundraising by VCTs and IHT-exempt products. We have also seen overseas institutions participating in issues of equity by quoted and private UK companies on a relative value basis. Demand for AIM IPOs and secondary placements has been strong, although the holiday period and uncertainty about continuing Covid regulations have caused some recent issues to be cut back and repriced.

 

This article appeared in Business Leader - Money Supplement. To read the full debate, click here.

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