This article highlights three ways to finance a start up in Scotland or England & Wales by providing an overview of debt, equity and hybrid financing options. For a summary on some of the different legal structures available to new businesses please click here.
1 Debt Financing: Bank Loans
This type of debt financing is when a Bank lends money to you, or the business, dependent on the legal structure you have chosen for the business, for a designated purpose. For more information on loans please click here.
2 Equity Financing: Sale of Shares/ issue of shares
Equity financing is a means of raising capital through selling shares in a company. A fundamental difference between debt and equity financing is that in the latter case, the party injecting capital is doing so as an investor rather than a lender, and is therefore exchanging their money for shares (a percentage of ownership) in the company. This characteristic of equity financing presents unique challenges, as the percentage of ownership in the company the investor receives in exchange for money, will ultimately dictate their level of control during decision making, by virtue of the investor's shareholding.
The company and its shareholders should consider seeking legal advice on the terms and conditions of an equity investment, as these can often be complex and have consequences which are not apparent at the outset.
3 Hybrid: Convertible Loan Notes (CLNs)
CLNs can be viewed as a hybrid between debt and equity financing, as they are essentially a loan to a company which will either be repaid or, in most cases, converted into equity at a discounted conversion price at some point in the future. CLNs are therefore only available as a financing option to businesses set up as a company limited by shares.
When CLNs convert into shares is a matter for negotiation between the company and the investor. Example trigger events include a future equity financing of not less than a pre-agreed aggregate amount, a change of control (or sale or liquidation) of the company, or conversion taking place at an agreed date. This flexibility makes CLNs an attractive financing option for start-up and early-stage businesses, as they allow the company to raise money quickly whilst keeping control in the hands of the founder(s)/existing shareholder(s).
However, CLNs are not without disadvantages for the company. The fact that CLNs do not qualify for Enterprise Investment Scheme (EIS) or Seed Enterprise Investment Scheme (SEIS) relief makes them less attractive to investors (not the case with equity investments provided the relevant criteria are met). Also, whilst the negotiation time for CLNs is notably shorter than an equity investment, CLNs are certainly not without complexity, and it is important for the company (and its shareholders) to take advice on, and understand, the trigger events and conversion price/mechanism. For more information on CLNs please click here.
If you would like to discuss debt or equity financing options for new businesses further please do not hesitate to get in touch with a member of our market leading Banking & Finance or Corporate.
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