Is debt or equity best for growing tech businesses?

By Dominic Buch, co-founder and managing partner, Caple

For ambitious tech business owners, how best to raise growth funding can be one of the most challenging decisions they face.    

With the rise of alternative financing, tech entrepreneurs and business owners can choose from many different options. 

However, quite often, the basic choice still comes down to one of two alternatives: equity financing or debt funding. 

Put simply, equity financing is where the business owner obtains capital in return for a share in their company.  The funds might come from venture capital, private equity or peer-to-peer or crowd funders. 

Debt funding involves securing a loan which is repaid over time, with added interest payments.  This funding might be supplied by a bank, a specialist debt fund or an alternative provider.

How does equity financing stack up? 

Equity financing may provide the funding the business requires to grow.  

The benefits of equity funding are that the investor assumes the risk.  If the business fails, the owner does not have to pay back an equity investor. 

Third-party investment does not suit every sector, business or owner manager, however.  It also dilutes ownership immediately and over the longer term it dilutes the reward if the business is sold.

Our own research of 300 SME business owners shows they do not want to issue equity in their business to fund growth.  Indeed, more than half (53%) would be unlikely to do so. 

When looking at the reasons why, many business owners feel they don’t need someone else telling them what to do. 

What about debt financing?  

Debt funding, especially from traditional banks and specialist debt funds, often requires security – or a physical asset against which the loan is secured.  Such physical assets might include property, stock or machinery. 

However, getting such secured funding can be a problem for tech businesses.  Most tech firms simply do not have necessary physical assets to use as security.  

Instead technology businesses are based on intangible assets, such as data, networks, and software. 

So, while banks can provide funding that reflects the value of the assets in a business, they can’t help if a business has no further assets to borrow against. 

Where a physical asset isn’t available, banks or funds may ask the owner to agree to a personal guarantee.  Often these personal guarantees can be as high as 20% to 30% of the loan value.  

If a firm is borrowing £1m or more you can understand why the owner might not want the personal risk. 

As a result, ambitious tech firms must often consider the difficult choice of scaling back their growth, diluting their ownership or agreeing to onerous personal guarantees. 

However, asset-light businesses, such as tech firms, can now benefit from unsecured lending. 

Unsecured lending is based on an understanding of the future cash flows generated by the business.  

Such unsecured lending provides the finance tech firms need to grow while removing the need for security and personal guarantees.  

Crucially, it means owners do not need to give up ownership or control.  

When innovation is so important for growth and prosperity, we need to do all we can to help fund that innovation.

We need to help tech firms to access unsecured lending for growth.