Thu, 22 Aug 2013 | By Philip Ellis, principal, Optima Corporate FinanceMany recruitment businesses have ambitions to grow, either now or in the future. These ambitions can be limited by a number of factors, funding is often being among them. However, there are a number of financing options, which can be considered.
 
Businesses are funded using either debt or equity, or sometimes a combination of both. So what are the differences between debt and equity and is one ‘better’ that the other?
 
Debt
 
Debt comes in more than one form. The most common options for recruitment businesses are:
 
•    Bank loan or overdraft
•    Factoring or invoice discounting
 
While bank loans or overdrafts are the most common form of debt for the general business community, recruitment businesses with temp or contractor books are ideally suited to factoring or invoice discounting. This can come in a range of shapes and sizes, but the underlying principle remains the same – borrowing against sales invoices.
 
The reason that this is so suitable for recruitment businesses is that the facility can grow with the business, whereas a bank loan or overdraft tends to be for a set sum. In either case, the debt will be secured by the assets of sales invoices. Unsecured bank borrowing is more difficult to come by these days and would require a lengthy track record of profitable business and cash generation to gain credit approval.
 
So what are the key considerations of a business taking on debt?
 
Pros:
•    Existing shareholders retain full ownership of the business
•    No outside parties can interfere with the running of the business
 
Cons:
•    The cost of interest on borrowings
•    Debt will be deducted in arriving at a valuation for sale
•    The worry of owing money to a third party
 
Equity
 
There are a number of potential sources of equity, including:
 
•    Friends and family
•    Private investors (business angels)
•    Venture capital trusts (VCTs)
•    Private equity
•    Existing recruitment groups
•    Stock market (eg. AIM)
 
Each of these options has its place and is most suitable for businesses at different stages, but the underlying principle is the same in each case – buying shares in a business with a view to the value of that investment increasing.
 
So what are the key implications of a business taking an equity investment?
 
Pros:
•    Potential ongoing source of funds for expansion (subject of course to investor terms)
•    No need to repay the funds invested
•    Shareholders may bring additional skills and contacts and have a vested interest in the success of the business

Cons:
•    On sale of the business, sale proceeds are shared between all shareholders
•    Loss of autonomy as shareholders are likely to want some involvement in the running of the business

The circumstances of a business need to be considered to determine which form of funding is most appropriate. But is one ‘better’ than the other? In many instances it comes down to the preference of the owners. Some prefer to be debt free and would rather have a smaller slice of a larger pie, whereas others are happy to gear up with debt and retain the maximum equity they can for when the business is sold. There are many examples of successes of each model.

If there were a “correct” structure, all businesses would be funded the same way.
 
Important Notice
It must be noted that taking in equity investment is a complex process and specific advice should be sought from a suitably qualified professional advisor.

This article is for information purposes only and no reliance may be placed on its content. Any liability for reliance on this article is specifically disclaimed by Optima Corporate Finance and recruiter.co.uk.

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