Most founders arrive at this question the wrong way round. They decide how much they want, then ask what to raise. The better sequence is to work out what the business can carry, and let that decide the instrument.
Here is the distinction that actually matters, and the test that settles it.
What each one costs you
Debt costs money. Equity costs ownership.
A loan note or bond obliges you to pay a fixed return on a fixed date, whether or not the quarter went well. In exchange you keep the whole of the upside and the whole of the control.
Equity has no coupon and no repayment date. Nobody can call a default. In exchange you have permanently sold a share of every pound the business will ever make, and you have acquired shareholders with views.
Neither is cheaper in the abstract. Debt is cheaper if the business performs. Equity is cheaper if it does not.
The test
One question decides it more often than any other: can the business service a fixed payment out of current cash flow, without assuming the plan works?
If yes, debt is usually the better trade. You are borrowing against something real and keeping your company.
If no, debt is not cheap capital, it is a deadline. Companies that raise debt on the strength of a forecast are betting the business on that forecast being right to the month.
Where each one fits
Debt fits a specific, time-boxed need with a visible repayment source. Bridging a development to completion. Funding a purchase order against a signed contract. Refinancing an expensive facility. The money has a job and the job has an end date.
Equity fits open-ended risk. Building a product nobody has bought yet. Entering a market you have not tested. Anything where the honest answer to “when does this pay back” is “it depends”.
The middle ground
Convertible loan notes sit between the two. They start as debt and can turn into equity, usually at a later round and often at a discount. They defer the valuation argument, which is useful for a young business without a defensible number.
The thing to watch is what happens if the next round never comes. Read the maturity terms before the conversion terms.
What investors read into the choice
Experienced investors treat the instrument as information about the founder.
A debt raise says: we can service this, and we would rather not sell equity. An equity raise says: this is uncertain, and we are sharing that. Both are respectable positions.
What is not respectable is a debt instrument attached to a business with no revenue and no asset, dressed up with a headline rate. That tells an investor either that the founder has not done the arithmetic, or has and is hoping nobody else will.
In practice
Settle this before anything else. Once outreach begins, changing the instrument means re-explaining a moving target to people who have already formed a view.
Start from what the business can actually service and what it can actually secure. The right answer usually falls out of those two facts without much argument.
Related reading
- What is a loan note, and how does it work?
- Convertible loan notes explained
- Bonds or loan notes: which suits your raise?
Mark Johnson is a Director of BDM Wealth Management, which introduces capital raising opportunities across bonds, loan notes, IPOs and SEIS/EIS. To discuss a raise, get in touch.
BDM Wealth Management is an introduction business and is not regulated. This article is general information, not financial, tax or legal advice, and does not constitute an offer or invitation to invest. Capital is at risk and you may get back less than you invest. For high-net-worth and sophisticated investors only. Take independent professional advice before making any investment decision.