If your business needs capital to grow, one of the first decisions is how you want to fund it.
Two of the most common options are equity funding and debt funding.
With equity, an investor provides capital in exchange for ownership in your business.
With debt, you borrow money and repay it over an agreed period, usually with interest.
Neither is automatically better. The right option depends on what you’re funding, how established the business is, its ability to generate cash and how much ownership you’re prepared to give up.
What is equity funding?
Equity funding involves raising money from an investor in exchange for shares in the company.
For example, an investor might provide £1 million in exchange for 20% of the business.
Unlike a loan, the £1 million doesn’t normally need to be repaid on a fixed schedule. Instead, the investor participates in the future value of the company.
If the business grows significantly and is eventually sold, their shares may become worth considerably more than the original investment.
What is debt funding?
Debt funding allows you to raise capital without giving away ownership.
A lender provides the business with money which is then repaid, usually with interest, over an agreed period.
Depending on the funding, the lender may require security, financial covenants or personal guarantees.
The major difference is that repayments need to be made regardless of whether the business performs as well as expected.
Equity vs debt at a glance
| Equity funding | Debt funding | |
| Ownership | Investor receives shares | You retain ownership |
| Repayments | Usually no scheduled capital repayments | Regular repayments are normally required |
| Interest | No traditional interest | Interest is payable |
| Investor return | Comes from future value, dividends or exit | Comes primarily from interest and fees |
| Cash flow impact | Usually lower in the short term | Repayments reduce available cash |
| Control | Investor may receive voting or governance rights | Lender does not usually become an owner |
| Risk to founder | Dilution of ownership | Financial repayment obligations |
| Best suited to | Businesses where raise capital and risk-sharing are important | Businesses with sufficient predictable cash flow to service borrowing |
The exact terms will vary significantly between investors, lenders and individual transactions.
When might equity funding make sense?
Equity can be particularly useful when the business needs significant capital to pursue growth but doesn’t yet generate enough cash to comfortably support debt repayments.
For example, you may want to expand internationally, invest heavily in technology, open new locations or make acquisitions.
An equity investor may also bring more than money.
The right investor can provide experience, industry relationships, strategic support and access to future capital.
But that comes at a price: you are giving away part of the future value of the business.
When might debt make sense?
Debt can be attractive for established businesses with relatively predictable cash flows.
If the company can comfortably make repayments, borrowing allows existing shareholders to fund growth without giving away equity.
Once the debt has been repaid, the shareholders still own the same proportion of the company.
The important question is whether the business can comfortably support the repayments while continuing to invest in its operations and growth.
What does dilution actually mean?
Suppose you own 100% of a company valued at £4 million.
An investor agrees to invest £1 million at that valuation.
After the investment, the company would have a £5 million post-money valuation and, in this simplified example, the new investor would own 20%.
You would own 80%.
You now own a smaller percentage, but the objective is that the investment helps create a much more valuable business.
Owning 80% of a £20 million company is clearly worth more than owning 100% of a £4 million one.
The question is whether the capital and investor can realistically help create that additional value.
Consider control as well as ownership
Equity investment isn’t only about the percentage of shares you give away.
Investors may negotiate rights around major decisions, future fundraising, dividends, board representation and the eventual sale of the business.
Make sure you understand what rights come with the investment.
Two investors offering the same amount of capital for the same percentage of the company may still be offering very different deals.
Can you combine equity and debt?
Yes.
Many businesses use a combination of funding sources.
A company might raise new equity from an investor while also putting a debt facility in place.
The equity provides additional capital and strengthens the balance sheet, while debt can increase the total funding available without requiring further dilution.
The right balance depends on how much financial risk the business can support.
Think about what the capital is for
Before choosing a funding route, be clear about what you’re trying to achieve.
How much capital do you need?
What will it be spent on?
When will that investment generate a return?
Can the business service repayments?
How much ownership are you prepared to give up?
And what happens if growth takes longer than expected?
The funding structure should support the business plan rather than put unnecessary pressure on it.
Finding the right funding partner
Raising capital isn’t simply about finding someone willing to provide money.
You need a funding partner whose expectations fit with your own.
For debt, that means understanding the repayment structure, interest, security and covenants.
For equity, it means understanding the investor’s time horizon, involvement, return expectations and plans for an eventual exit.
The cheapest or highest offer isn’t necessarily the right one.
Look at the whole relationship and what it means for the business over the years ahead.
Find investors and funding partners on The Brokerage
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Create your capital raise profile to present your opportunity and connect with relevant investors and funders.