Debt vs equity funding: alternatives to selling shares in your business

This guide is for founders and owner-managers weighing an investor against a lender, often after a first conversation with an angel or a crowdfunding platform. Smart Funding Solutions arranges debt, not equity: we are a broker searching lenders on our panel for facilities from around £10,000 to £500,000+, with larger facilities available in suitable cases. We explain equity fairly here so you can compare like with like. More guides are in our business finance guides.

01The real difference: who shares the upside

A lender's return is capped. It receives interest and fees, and it gets its money back if the business performs. If the business becomes ten times bigger, the lender gets nothing extra. An investor's return is uncapped. They own a slice of the company for as long as they hold the shares, so if it becomes ten times bigger, their slice does too.

That is why the two sides ask such different questions. A lender asks "will you be able to repay?", so it looks at the last two or three years of accounts, current margins and existing borrowing. An investor asks "how big can this get, and how do I exit?", so it looks at the market, the team and the route to a sale or further funding round. A profitable, steady company growing at a modest pace is usually a better fit for debt than equity, and a pre-revenue technology company with a large addressable market is usually the reverse.

02The main equity routes

Angel investors

Wealthy individuals, often former founders, investing their own money at an early stage, alone or in syndicates. Many invest through the Seed Enterprise Investment Scheme or Enterprise Investment Scheme, which give investors income tax and capital gains reliefs if the company and the shares qualify. HMRC's guidance on using SEIS to raise money sets out the company conditions. Angels can add useful experience; they also expect a seat at the table and a say on major decisions.

Venture capital

Professional funds investing other people's money in a small number of companies that could grow very large. VC terms usually include preference shares, investor consent rights, board seats and an expectation of a sale or listing within the fund's life. Most trading SMEs, including many profitable ones, are not what VC funds are built to back.

Equity crowdfunding

Selling shares to many smaller investors through an online platform. It can suit consumer brands with a loyal customer base. Campaigns take significant preparation and marketing, the platform takes a fee, and you gain a large shareholder register to keep informed. The FCA's investor-facing explainer on understanding crowdfunding shows the risks your investors are being warned about.

Private equity and family money

Private equity typically backs established, profitable businesses, often buying a majority stake. Money from friends and family is the most common early equity of all, and the one most often done without proper paperwork.

The British Business Bank's guide to what equity finance is and how it works is a sensible neutral overview.

03Debt alternatives to equity funding

Professional funds investing other people's money in a small number of companies that could grow very large.

04What equity actually costs

Equity feels free because there are no monthly repayments. Its cost appears later, and it can be the most expensive money a business raises.

Illustration: a founder sells 20% of a company for £200,000. Five years later the company sells for £5 million. The investor receives £1 million. Had the founder instead borrowed £200,000 and repaid it with interest over those five years, the total cost would have been a fraction of that, and the founder would have kept the full sale proceeds. If the company had struggled, though, the loan would still have had to be repaid, while the investor would have shared the loss. The figures are hypothetical and ignore tax, dilution from later rounds and preference terms.

Beyond money, equity brings shareholder agreements, consent rights over borrowing, hiring or selling the business, and investors whose timetable for exit may not match yours. Debt brings covenants and, often, personal guarantees. Our guide to personal guarantees explains what a director signs up to.

05What lenders look for instead of a pitch

• Trading history: most lenders want at least one to two years of filed accounts, though some revenue-based and card-linked lenders work from shorter histories.
• Serviceable cash flow: profit and bank inflows that cover existing and proposed repayments with room to spare.
• Existing debt: how much is already borrowed and from whom, including director loans to the company.
• Use of funds: a specific plan, such as a contract, a hire or new equipment, with a believable payback.
• Director position: personal credit history and willingness to give a guarantee where required.
• Growth rate: fast growth is welcome, but lenders check that working capital can keep up with it.

That last point is where businesses between the equity and debt worlds often get stuck. In one case we arranged, a UK training provider scaling rapidly into a national business needed a significant injection of capital. We worked across the alternative lending market and a £600,000 facility for the growing training business completed, followed later by further facilities, including £400,000, as it continued to expand. External funding gave it the capital capacity to keep expanding rather than being limited by the cash already in the company.

06Combining debt and equity

It is not always either/or. A company that has raised equity is often easier to lend to, because the investment strengthens the balance sheet. Some businesses raise a smaller equity round and use debt for assets and working capital, keeping dilution down. Lenders will want to read the shareholder agreement, since investor consent may be needed before the company can borrow or grant security.

07Documents a lender will ask for

08How we can help

1. We review your trading figures, existing borrowing and what the money is for.
2. We tell you plainly whether debt looks realistic now or whether equity or waiting would serve you better.
3. Where debt fits, we approach lenders on our panel whose criteria match your profile.
4. Lenders make the decision; you compare offers and choose. It is free to enquire; any broker fee is disclosed separately before you proceed.

If you are also considering public funding, see business grants versus business loans.