Recruitment Insights

Debt vs giving up equity, what you should know

March 23, 2017
Debt vs giving up equity, what you should know

If you’ve been in recruitment for a while, you will probably know by now that finance is (or was) often referred to as a debt. What’s more, it carried a negative stigma and conservative business owners wanted to avoid it – at all costs!

However, times have changed, and now a reluctance to consider finance can be seen as stunting the growth of your business or, at the least, missing opportunities to achieve your goals.

Top reasons for finance

There are usually a few common stages in a business’s life cycle when you need more cash:

  1. When you start up, this is when your small business has growing overhead expenses and an increasing payroll.
  2. If your business needs finance to plug a hole caused by tight margins or to align the timing of cash inflows and outflows. Many businesses, such as labour hire, have a natural trade cycle where suppliers (in this case payroll) need to be paid before the customers pay.
  3. If you’re looking to expand. You might be taking on more staff, looking to acquire another business, or branching into a new area such as adding equipment hire to your labour hire business.

So, what’s the difference between debt vs giving up equity

Put simply, if you need to raise funds for your business, giving up equity is likely to be more expensive in the long-term than taking on debt. Why? Equity will cost you a portion of your business forever.

While investors can help raise capital, you could be sacrificing future profits indefinitely to fill a short to mid-term need.Instead, while you will incur some interest costs, taking on debt to finance your business growth is temporary and it’s capped. In short, once you pay it back, your equity remains intact.

Furthermore, the cost of paying interest on debt reduces your taxable profit and, therefore, reduces your tax expense. Plus, another positive side effect of taking on debt is that it can encourage discipline around spending and investing.

Decide what finance option suits you

When your trading cycle is negative and you need to pay payroll before the customer pays you, the question is not “do I need finance?” but “how can I fund it?” There are generally three options to choose from:

  1. Your own cash (which can include profits, owners’ cash, loans from friends or relatives, or external equity investors);
  2. Overdraft;
  3. Debtor finance or payroll funding.

Without your own cash reserves, the first point of call is usually the traditional overdraft. In the current economic and credit climate, it is difficult for SME businesses to access any reasonable size overdraft without a good level of property security. Even if this is available, the overdraft option does not suit early stage businesses without the required trading history.

Instead, debtor finance or payroll funding can be a good option for recruitment businesses as they use the only major asset of the business – the invoices outstanding – to facilitate the funding line.

Remember, debtor finance is the generic name for funding against the debtors of a business. Providers of this type of finance have generic finance products to cover all B2B industries. Payroll funding provides funding against the invoices raised by recruitment businesses with the predominant focus to cover the payroll commitment.

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