How to finance your company’s growth: private equity or bonds?
Andrejus Boicovas, Partner, Raft Capital Management, UAB
Securing adequate funding is crucial for any company seeking rapid growth. It’s all good if there is sufficient equity or bank lending. Otherwise, the two popular options are currently considered – private equity and bonds.
Both funding types have unique advantages and certain trade-offs. Which option to choose will depend on the company’s objectives, risk appetite, long-term vision and even shareholder structure.
When a company is looking to invest in growth, the choice of financing can have a lasting impact on its success and sometimes even hasten the end of the business. Two main options are commonly considered: private equity and bonds.
Both options have their advantages and challenges. Let’s look at the pros and cons of each option and when to consider them.
Private equity: partnership for long-term success
Private equity usually provides access to large amounts of capital, often accompanied not only by investment but also by strategic experience, know-how and industry connections.
In return for the funding and expertise they provide, private equity funds often receive a stake in the investee company and become an active advisor in the company’s operations and decision-making.
Benefits:
- Strategic support: private equity not only provides funding, but also offers expertise, management resources and often a network of industry contacts.
- Flexible repayment: unlike debt, private equity funds do not require periodic repayments. Instead, investors share in the profits, either when the company is sold or in the event of an IPO.
- Long-term investment prospects: private equity funds can expect returns over a long period of time – three, five or even seven years. This provides stability for ambitious business growth plans.
Disadvantages:
- Loss of ownership: the biggest disadvantage often feared by the older generation of Lithuanian founders, who are used to being small orchestras, is the relative loss of control. Often, when a company brings in a private equity fund, it also transfers part of its shares to the fund. Fund representatives often become board members, so there is a need for more consultation and joint solutions.
- Pressure for high returns: private equity investors expect above-average returns. This can sometimes be frightening for somewhat “entrenched” business owners or managers who, used to relatively low growth targets, avoid or postpone operational changes.
Bonds: debt without dilution
For companies that want to retain ownership, issuing bonds can be an attractive alternative. Bonds, which have become quite popular in Lithuania in recent years, are a form of debt in which a company borrows money from investors in exchange for interest and the final repayment of the principal at the end of the debt period. In a period of high interest rates, this was a popular way for successful growing businesses to lend their money.
Benefits:
- Preservation of ownership: bonds do not confer a right to participate in the management of the company, so there is no need to give up shares when issuing bonds. This allows the founders and existing shareholders to retain full control of the company.
- Predictable costs: companies can predict the interest burden and the amount they will have to repay over time, which makes financial planning somewhat easier.
- Reputation building: a successful bond issue, including the refinancing of existing bond liabilities, can improve a company’s creditworthiness and reputation in the financial markets, provided of course that it is in line with specific business objectives, such as accessing capital markets or attracting export partners.
Disadvantages:
- Debt burden: companies are required to pay regular interest payments on issued bonds, which can complicate cash flow, especially in periods of economic downturns or slow growth.
- Low strategic value: bonds do not offer the strategic input or flexibility that private equity can offer. The focus is purely on financial returns.
- Credit risk: companies with lower credit ratings, as well as those in more vulnerable or declining sectors, will face higher interest rates, making it more expensive for them to issue bonds.
Which option is best for your business?
When choosing between private equity and bonds, it is important to strike a balance between control and risk. Companies with high growth potential, but still lacking the necessary experience, may prefer to use private equity. For such companies, it is not only important to secure financing to, say, enter foreign markets or to break out of the medium to large company league. This breakthrough requires strategic support, which can come from the experience, knowledge and contacts that a private equity fund can bring.
On the other hand, companies with sufficiently strong cash flows and a desire to maintain absolute autonomy may choose to issue bonds to avoid dilution of share capital and to maintain control.
After all, there is no one right solution for everyone. Every business owner needs to carefully assess their growth objectives, risk appetite and the value of ownership to choose the best way forward. Whether it’s the helping hand of private equity or the autonomy provided by bonds, the key is to align financing with the long-term vision of the company.
Raft Capital Management, UAB manages the IISUTIB Raft Capital Baltic Equity Fund, a fund designed to invest in high-growth potential Baltic companies. The company is based in Vilnius, and operates in Lithuania, Latvia and Estonia.
