Debt or Equity: What Growth Capital Really Costs
Growth Funding

Ask most founders how they will fund the next phase and the answer is a funding round. Equity has become the default, partly because it is the version that gets written about.

For a profitable owner-managed business it is usually the most expensive money available. Not because of what it costs today, but because of what it costs in the year you sell.

Equity feels cheap because nothing leaves the bank account

There is no repayment schedule, no interest line in the profit and loss, no covenant to breach. Nothing about equity shows up in the monthly numbers, which is exactly why its cost is so easy to underestimate.

What you have actually done is sell a permanent share of every future pound the business makes, at a price set by what the business is worth today.

The arithmetic is unforgiving. Sell a quarter of the business at a two million pound valuation and you have raised five hundred thousand pounds. If the business is eventually worth eight million, that quarter is worth two million. You did not borrow five hundred thousand. You paid two million for it, settled at the worst possible moment, which is the moment you were finally getting paid.

Debt has a finite cost. You know the number when you sign, it appears in the accounts every month, and when the last payment clears it is gone. That visibility makes it feel expensive. It is the reason it usually is not.

Where equity genuinely is the right answer

This is not an argument that equity is always wrong. It is the right instrument in specific conditions.

When the business is pre-profit or burning cash, because there is nothing to service debt with. When the growth curve is steep enough that the dilution is outweighed by getting there years earlier. When the money is going into something with no asset backing and no near-term return, such as building a product before it sells. When the investor genuinely brings something other than money: customers, sector knowledge, credibility in a market that is closed to you.

The common thread is uncertainty. Equity is the correct instrument when nobody can sensibly predict the cash flows, because a lender cannot price something nobody can predict.

Where debt fits better than people assume

Debt works when three things are true, and for a lot of established owner-managed businesses all three already are.

Predictable revenue. Recurring subscriptions, contracted income, a customer base that renews at a rate you can evidence.

A demonstrable return. A clear line between the money going in and the revenue coming out. Additional capacity, a machine that produces something you can already sell, a hire who is filling an order book that exists.

Something to lend against. Debtors, stock, plant, property. Asset-backed lending and invoice finance are frequently cheaper than owners expect and are dismissed without being priced.

If you have all three and you raise equity instead, you are paying for certainty you already possess.

The middle ground most owners have not looked at

The choice is not binary, and the market between the two is larger than it was.

Venture debt sits alongside an equity round and extends the runway between raises with limited dilution, usually with warrants attached, which are a small equity participation for the lender. Asset-based lending flexes with your debtor book instead of a fixed repayment schedule. Growth funds and regional funds lend to businesses that high street banks find awkward, often on terms that surprise people who have only ever spoken to their own bank. Some structures blend the two, with repayments that step up as revenue does.

Getting a bank decline and concluding that debt is unavailable is one of the more expensive mistakes in this area. It usually means one lender said no.

The questions worth asking before either

Four, in order.

What is the money actually for? Working capital, an acquisition, product development and a hiring plan are four different problems, and they do not take the same kind of capital.

When does it come back? If the return is measurable within a normal facility term, that points at debt. If it is speculative or years out, it does not.

What does this do to a future sale? Investors have rights that outlast the cheque: consent rights, information rights, liquidation preferences, and often a view on when and to whom you sell. Owners discover in year five that they no longer control the timing of their own exit. That is a cost, and it is not on any term sheet as a number.

What can you actually service? This is where it becomes arithmetic rather than preference, and where a rolling forecast built from contracted revenue earns its keep. If you cannot say what you can service, you are not ready to ask either party.

The honest summary

Equity is patient, expensive and permanent. Debt is cheaper, finite and unforgiving of a bad quarter. Most owner-managed businesses with predictable revenue reach for the first when the second would serve them better, because the first has no monthly reminder attached to it.

The decision is worth modelling properly rather than deciding by instinct, and the modelling is not complicated. It requires knowing your own numbers well enough to say what the business can service, which is the same requirement as almost everything else worth doing here.

If a raise is on the horizon, funding and growth covers the model, the pack and the process. If the honest answer is that the numbers are not clean enough yet to make the case, management accounts is the place that starts.

This article is general information, not advice, and nothing in it is a recommendation to raise capital in any particular way or to acquire or dispose of any investment. What is right for your business depends on circumstances an article cannot see.