Is it better to raise funds by selling equity in your business … or by invoice discounting?
The opportunity cost of selling equity is high
Raising cash by selling equity is a high cost option. By issuing equity you permanently give up a portion of your business … as the value of the business grows so too will be the “cost” of selling equity. Its difficult to quantify this cost, however as an example if your business is growing at 10% a year, the cost of the equity sold will increase by close to 60% over 5 years.
This compares to Invoice Discounting which does not reduce your ownership, and is short term and temporary in nature.
Raising cash by selling equity is also complicated. Selling shares will require a valuation of the business as a whole, and then involves the preparation of a disclosure document, presentation materials and associated legal agreements. You will also need to identify and contact potential investors, and negotiate the share sale often with multiple investors.
By comparison Invoice Discounting requires only the execution of a standard agreement to get up and running, often within 24 hours.
Transaction costs are high
Raising equity funding is an expensive undertaking. Costs will include legal and accounting advice ($10k to $20k), preparation of an offer document ($5k), and often fees paid to an intermediary to source an investor(s) of between 2.5% to 5.0% of the amount raised. Invoice Discounting is often free of fees, or incurs only minimal fees to recover costs.
Long lead time to raise funds
The “lead time” to raise equity funds is considerable – realistically a minimum of 6 months. An Invoice Discounting facility can be arranged and funds advanced within days.
Invoice Discounting is re-usable
Due to the opportunity cost, complexity and transaction costs, it is not feasible to raise funds by equity raising on a regular basis, so should be reserved for significant “one off” transactions or events. Invoice Discounting facilities on the other hand are “evergreen”, meaning they are always in place, and can be re-used as often as required.
Raising funds by selling equity (shares) definitely has a place in the overall funding mix of a business. However due to the intrinsic and transaction costs, long lead time and complexity this form of funding should be reserved for only significant “one off” opportunities, and should not be seen as a source of funds to meet day to day cash requirements.
Invoice Discounting on the other hand is the opposite – it is designed to provide funding to meet short term cash shortfalls, and is quick and easy to arrange at a fair cost substantially below the cost of selling equity.