Why debt investment might be a better option than you think

Matt Browning, Head of Investment at Creative Growth Finance on the lesser-known advantages of debt investment for businesses.

‘Debt’ can be a scary word for a business seeking investment, but – just like equity, debt has its place. The question that I will try to answer in this article is what is that place? And in particular, when is it the right choice for a company that is looking to scale?

The yin to equity’s yang, debt is a form of finance that has been maligned through the years thanks to associations with everything from the credit crunch right through to mortgage rate hikes.

While it is private equity making the news about lowered valuations and expectations, it is debt that tends to play the villain when the conversation is investment. Of course, binary perspectives are rarely a wise way to approach anything, and investment is no different. So, while there are undoubtedly major differences between debt and equity, it’s not necessarily a case of either or. For many businesses a combination of the two will provide the answer, but for the sake of clarity, let’s go back to basics.

The two most traditional methods of raising finance for a business are equity and debt investment. Equity is the sale of a shareholding of your company which is sold with the expectation of a greater value for the investor when they ‘exit’ at a later stage, for example in an IPO sale. 

Debt is more straightforward: it’s an investment that must be paid back with commercial returns, which normally means interest. These are fairly broad churches and within the label of business debt, you can find several types, the main three being:

1- Secured: This is debt which is secured against collateral, such as property.

2- Unsecured: This is a riskier form of debt which costs more but does not have to be secured against anything. 

3- Venture: Venture debt is the rockstar of the three – the form of investment that seeks future big hitters by securing investment against expected future revenues and growth.

*other forms of debt are available

Equity can often seem attractive to early-stage businesses because, unlike debt, it doesn’t incur an immediate cost. By exchanging a share of your company in return for investment, you benefit from easily deployed working capital that can be funnelled into a business plan.

And, all being well, you also benefit from the hard-earned wisdom of an investor who now has a stake in your success. Their advice and experience could have a significant impact on the way you move your business forward. 

But it can be quite costly in terms of what you’re losing. The equity is basically giving away a stake in something that you’ve built and founders should be wary of undervaluing what they are surrendering. An equity partner can mean a loss of autonomy as you now have more people to answer to. It’s important to remember this when making an investment decision and not to get blindsided by the absence of monthly interest payments. After all, nothing in this life comes for free!

Debt is by no means right for every business, but for those that have proven revenue models and the ability to service a loan, there are numerous advantages. A major pro is that you will know exactly how much you’re going to repay to your lender and when. You might not like the number, but having it means that you can put together a decent financial model to forecast for the future.

A secondary advantage of this is that the financial discipline required by servicing debt can lead to enhanced resilience, no insignificant thing at a time when ‘challenging’ seems like the politest way to refer to the economy. The positive financial behaviours that debt servicing tends to elicit can give businesses the kind of serious grounding that means they are both more profitable and more attractive to future investors. 

Creative Growth Finance is the £24 million debt fund that I manage alongside my team at Creative UK Investment. As it is now in its fourth year, it offers a good lens through which to view the realities of debt servicing for small businesses. 

Launched in 2019, Creative Growth Finance (CGF) has made 35 investments, with many of the recipients taking investment during or just before Covid. Perhaps surprisingly, the number of our CGF clients who defaulted during (and since) Covid is… zero. This is especially remarkable when you consider that the fund is invested in companies within the UK’s creative sectors – some of those hardest hit by the pandemic. 

The portfolio comprises 27 companies representing sectors such as software, virtual production, immersive tech, marketing and architecture. Of these 27 we’ve seen two businesses already fully service the debt and one that has acquired another company while continuing to service it; we’ve also had businesses going public and nearly all have upped their headcount.

As I mentioned earlier in the article, I’m not trying to suggest that debt is the only way forward; it really depends on your business, but many of our CGF clients are going through (or have been through) fundraising rounds that are complementary to the debt. In some cases, the fact that clients can show their financial reliability through the servicing of this debt has helped them to appear more attractive to VCs and other investors.

The lesson to take away is that equity is not the only play. With the volatility of markets that we are seeing right now, knowing the true cost of investment can be invaluable to a business and debt allows this. If your business is post-revenue and operating within any of the Creative Industries sub-sectors then Creative Growth Finance could be right for you. You can learn more about our debt fund and try our online eligibility checker by visiting our website.

Matt Browning is the Head of Investment at Creative UK whose current fund, Creative Growth Finance remains open to applicants until late summer 2023.